US Dollar Index Still Unable to Register Decisive Break Despite US Fed Update

The US Federal Reserve gave markets a dose of reality when they released a measured set of minutes from the January FOMC meeting allowing the USD to extended its recovery.

Those looking to buy US dollars in the future may have to pay more for their buck after positive news from the Fed and data on Wednesday improved sentiment towards the currency.

The Fed January meeting minutes, released in the evening, delivered the message that central bank policy makers were unshaken by recent negative developments in global markets.

In fact, markets were actually pricing the US dollar at levels that suggested no interest rate rise would occur in 2016.

Several participants noted, "waiting for additional information regarding the underlying strength of economic activity and prospects for inflation before taking the next step to reduce policy accommodation would be prudent."

Most importantly, the minutes dismissed claims the U.S economy could be about to enter a recession, continuing to point out its strong points in the labour market and housing:

“Average hourly earnings for all employees increased 2-1/2 percent over the 12 months ending in December, about 1/2 percentage point more than over the same period a year earlier.”

Helaba Research, noted that market based indicators of when the Fed might hike rates again had rebounded slightly following the release of the minutes:

“Market expectations regarding the US key rate trend have increased again slightly. While a rate hike by November was trading at a probability of 0% last week, the probability is now back to around 25%."

The rebound in rate expectations has seen the dollar exchange rate index attempt to break the 97.00 resistance point.

The dollar index is a measure of the US dollar against a basket of currencies with the EUR/USD bearing the heaviest weighting.

It serves to give an overall feel of sentiment and performance as related to the dollar. As we can see the trend for the past 7 days has been to the upside:

We would want to see the index break above 97, or at least end the day higher than where it opened, to give us confidence that the Greenback was looking to assert its dominance once more.

Don't Get too Carried Away

Nevertheless, in its forecasts the Fed remained cautiously aware of the potential for a ‘global shock’:

“The downside risks to the forecast of economic activity were seen as more pronounced than in December, mainly reflecting the greater uncertainty about global economic prospects and the financial market turbulence in the United States and abroad.

According to Carl Hasty, Director of Smart Currency Business, the Fed had sent a sign that it was still too early to assess the impact of global developments on the U.S economy:

“It also said it was too early to determine the impact these (global) problems would have on the US economy and their ability to raise interest rates again this year.

“Wait and see seems to be the message.”

Analysts at Swissquote, however, saw a more dovish message:

“Fed members were worried that the current global market turmoil and global slowdown could impact the US domestic economy and therefore derail the Fed rate path.

“Overall, we have the feeling that Fed members’ confidence in the strength of the US economy is eroding as they appear to be more and more cautious; especially when you compare the January minutes with the pre-rate hike speeches delivered by the most hawkish member.”

“This is still extremely low, but it seems that the subject of a rate hike is at least back in sight for the market,” say Helaba Bank who caution against getting too carried away that the Fed were now fully 'back on track':

“A massive rise in rate hike speculation is unlikely in the event of such a result.

“Low initial jobless claims will provide no reason to reduce rate hike speculation again, but whether market participants will increasingly speculate on continued Fed rate hikes on the basis of the robust labour market situation is questionable, especially as the index of leading indicators would have to surprise to the upside in this case.”

The dollar index has almost perfectly priced the wait-and-see / no-reason-to-panic message from the Fed as it retains some of the gains made over recent days while not exactly bursting higher.

If markets settle down then we could well see a stronger focus on US domestic data which will determine whether the recovery can extend.