Developments in the last 48 hours have finally given dollar bulls much-needed motivation to send the greenback higher. It started on Monday, with upbeat comments from New York Fed President Bill Dudley, who opposed his colleagues’ beliefs – by saying that he would favor a third rate increase this year. The crisis between the U.S. and North Korea has also appeared to ease, as both sides sought to lower tensions. Moreover, U.S. retails sales bolstered the third quarter growth outlook, recording their biggest gain in seven months, as consumers boosted spending. However, the magnitude of the dollar’s move was limited, and the dollar index is only up 1.3% from 2017 lows, and still down 8.4% for the year.
Despite the robust retail sales figures and the hawkish tone from Bill Dudley, expectations for a rate hike in December is still below 50%, according to CME’s FedWatch tool; indicating that one set of data is not enough to reverse interest rate expectations. Another factor that’s likely to keep dollar bulls on the sidelines, is skepticism on the political front. When President Trump first took office, he announced the creation of the Manufacturing Jobs Initiative, where a group of the largest business leaders’ firms joined to advise him. Seven of them have resigned already, with the latest being AF-CIO Richard Trumka and Deputy Chief of Staff Thea Lee, following the president’s inadequate response to an attack at a white nationalist rally in Charlottesville, over the weekend. Unless we get some political stability in the U.S., any rally in the dollar is likely to be limited.
Today’s Fed minutes may offer clues on the start of shrinking the $4.5 trillion asset portfolio. This should gradually send the longer end of the yield curve higher, but given that the news is already priced in, the impact on the dollar will be limited. I think the outlook on inflation will be the key thing to watch. Given the recent weakness in the Consumer Price Index and Personal Consumption Expenditure, markets need to know whether the Fed views the slow down as transitory or cyclical and whether it is something to be concerned about. The dollar will take its direction based on how hawkish or dovish the Fed is on the inflation front.
Sterling was one of the worst performing currencies on Tuesday, falling 0.7% against the dollar. The dip came despite the UK government published a paper, outlining Britain's desire to negotiate a transitional customs union arrangement, to take effect after UK leaves the E.U. Although this is considered a positive development and suggests that policy makers are seeking a soft Brexit, traders were still uninterested. Politics within the UK seems to have taken a back seat for now, and unless we see a positive response from Brussels, the pound will not respond. Weaker than expected inflation also added to the pressure, with July CPI remaining stuck at 2.6%, this suggests that the BoE will remain on hold throughout this year. The focus today will shift to UK employment data, and unless we see improvement in wages, sterling will likely remain under some pressure.