U.S. Dollar Creeps Higher Again as Market Mulls Fed's Toolbox and ECB Minutes, CBRT Decision Loom 

Image © Federal Reserve Bank of New York. Federal Reserve Bank of New York, Markets Briefing Room & employees entering, exiting the bank from main entrance at 33 Liberty Street.

• GBP/USD spot rate at time of writing: 1.3114
• Bank transfer rate (indicative guide): 1.2755-1.2847
• FX specialist providers (indicative guide): 1.2917-1.2996
• More information on FX specialist rates here

The Dollar crept higher Thursday as investors mulled over minutes of the July Federal Reserve (Fed) policy meeting in a session that also offers more about recent European Central Bank (ECB) policy deliberations as well as the path of Turkish interest rates, all with potential implications for major currencies.

Dollars were bought early in the Thursday session although the Euro and other large major currencies were unscathed by the rebound, with Sterling and other riskier major currencies bearing the brunt of it instead. 

This was after the Federal Reserve appeared to turn its nose up at the idea that a so-called 'yield curve control' policy could help policymakers shepherd the economy out of the pandemic and back to normal trading conditions. Investors have for a while anticipated that Fed officials might adopt the tactic, which has been the cornerstone of Japanese monetary policy for some time and would provide reassurance to the markets about the outlook for U.S. interest rates. 

"FOMC minutes are casting a shadow over markets and underline that any recovery is not going to be a straight line of advances. The Fed layered on the risks and caution thick, but didn’t come up with any sweeteners for the market in the shape of more easing," says Neil Wilson, chief market analyst at Markets.com. "Members clearly backed away from yield curve control and seemed to be in less of a hurry to push for clearer forward guidance."

Above: Dollar Index shown at daily intervals with Pound-to-Dollar rate (black line, left axis).

Minutes from the July meeting revealed that "most judged that yield caps and targets would likely provide only modest benefits in the current environment," effectively turning down one Dollar-negative policy option for pinning interest rates to the floor. Other parts of the meeting record did, however, make up for this when "various" policymakers appeared to support tying rates and monetary policy outcomes to developments in macroeconomic variables like the unemployment rate. This seemed lost on the market.

"Next week’s Jackson Hole meeting will provide a range of views on a longer-term policy regime, which is likely to be officially unveiled at the September FOMC meeting. The FOMC has essentially ruled out yield curve control as part of its framework review and current policy toolkit. We share the FOMC’s concerns over the lack of progress on new fiscal support and risks of new waves of Covid-19," says Daniel Ahn, chief U.S. economist at BNP Paribas. 

"Several participants" wanted to provide more support to the economy, not less, and "some" felt more fiscal support is needed from government. 

This is after Washington lawmakers failed on multiple occasions to agree an extension of the emergency unemployment support measures including further so-called stimulus cheques in recent weeks earlier funding provided by the CARES Act legislated in March already expired with the month of July.

"Let’s not get too worked up by this “risk-off” move – the US equity market remains in great shape but the correction was enough to give the US dollar another lift," says Derek Halpenny, head of research. global markets EMEA and international securities at MUFG. "The Fed looks less likely to announce any new meaningful policy strategy in September which could help remove some near-term downside risks for the dollar. Our view of potential near-term USD correction stronger therefore remains intact with scope for EUR/USD to correct further lower in the coming days and weeks."

Above: Euro-to-Dollar rate shown at daily intervals with Pound-to-Dollar rate (black line, left axis).

The Fed has already been clear about its intentions, saying in July that "over the coming months" it will continue to buy bonds of all different stripes "at least at the current pace" so that "smooth market functioning" is maintained and that policy supports a repair of the labour market and return to normal activity.

Rate setters have also increasingly come to view the Federal Reserve inflation target as "symmetric," which means they're unlikely to lift interest rates for an extended period even if the consumer price index rises above its 2% target. A symmetric interpretation could see inflation allowed to rise above target for as long as consumer prices undershoot it in the downturn. 

"The USD backed up sharply across the board yesterday, just a day after fresh notable lows in many pairs like GBPUSD. With this pair, unlike some other USD pairs, the move was both a product of USD strength and GBP weakness, encouraging the idea that the rally above 1.3250 in GBPUSD was a false breakout," says John Hardy, head of FX strategy at Saxo Bank. "A very interesting day yesterday for EURUSD, which may have just suffered a key tactical reversal, as the new highs above 1.1900 were rejected on the session as the U.S. dollar staged a broad comeback, both before and after the release of the FOMC minutes. The reversal starts to become more complete with a move below the 1.1800 level, which could open up a run for the major range support area around 1.1700."

Dollars were bought against many major currencies but the Euro-to-Dollar rate arrested earlier declines before resuming its northward advance ahead of an 11:00 interest rate decision from the Central Bank of the Republic of Turkey and a 12:30 release of minutes from the July European Central Bank meeting. 

Above: USD/TRY shown at daily intervals with Euro-to-Dollar rate (orange line, left axis) & EUR/TRY (black line, left axis).

The Pound, Euro and other major currencies could be volatile later Thursday amid the August policy decision of urkey's central bank at 11:00, with positive and negative surprises impacting GBP/USD and EUR/USD among others.

"We reiterate our call for a hold of the repo rate at 8.25% today with risks skewed to the upside. However, the notion that the CBRT would not be tightening policy if the repo is held steady is factually wrong. The CBRT has already been tightening rates for a month," says Cristian Maggio, head of emerging market strategy at TD Securities. "We see the risk of a continuation of tightening through quantitative measures going forward. CBRT stealth tightening is likely to continue for as long as TRY remains under pressure. An indirect indicator of upside pressure on USDTRY is the massive ramping up of CBRT's swaps this year, which has found new vigor in August."

Some in the market expect Turkish rate hikes to bring to an end in the months ahead, to a long cycle of rate cuts that's reduced the cash rate from 24% in January 2019 to 8.25% in 2020. This has crushed investors' real, inflation-adjusted returns from Turkish bonds and put the Lira under extreme pressure.

If the market decides to penalise the Lira for anything Thursday then EUR/USD and USD/TRY will be among the main henchmen involved because an increase in at least one of those is necessary to lift EUR/TRY, and if the Turkish currency is to really be punished, simultaneous increases are necessary.

This could impact GBP/USD because of the relationship with EUR/USD, although the UK is also a large Turkish trade partner and so Sterling exchange rates are also an important part of the Turkish Lira equation.