The Fed plays on the side of the bears

The comments of a Fed's leader contributed to the resumption of dollar sales after a brief period of stabilization.

The tone was set by a member of the Board of Governors, Lael Brainard, who outlined the main problems faced by the Fed early in the morning of Tuesday. In particular, she said that inflation remains low not only for the last year, but possibly for a much longer time. She continued that inflation may remain low for five years without rising above the target level. At the same time, there is a "sharp reduction in unused labor", in other words, a reduction in unemployment and employment growth.

The market reaction could seem excessive, if not for one circumstance. The leader of the Federal Reserve publicly expresses confidence in the rapid growth of inflation, guided by the well-known dependence between the growth of nominal wages and the level of unemployment from 1958. This dependence, discovered by the English economist A.W. Phillips and bearing his name is known as the Phillips curve. It serves as a basis for adjusting monetary policy since the growth of wages should automatically lead to an increase in inflation.

Thus, for the first time in a long time, Breynard outlined the main problem: the Phillips curve has stopped working. The reduction in unemployment did not lead to an increase in the average wage and did not contribute to the growth of inflation. Therefore, the Fed is dealing with some new challenge, the nature of which needs to be understood deeper before continuing to raise rates.

Futures on the rate, according to CME, indicate a 37% probability of rate hike in the current year, and the threshold of 50% will be overcome only by June 2018. This also means that the plans for next year is three upgrades which are currently under threat.


Later in the day, the position of Brainard was supported by other members of the Cabinet. The head of the Federal Reserve Bank of Minneapolis, Neel Kashkari expressed more specifically, in his opinion, the further increases in rates that he says could harm the US economy. That's why further increase should be refrained according to him. The head of the Federal Reserve Bank of Dallas, Robert Kaplan, also supported the pause in raising rates, saying that "it is necessary to show patience."

Thus, investors saw confusion in the speeches of the FRS leader and a desire to take a break, in order to better understand the situation. One of the two drivers, which contributed to the growth of the dollar, was virtually eliminated. The second driver which was the expectations of the tax reform of Donald Trump and the introduction of a package of fiscal stimulation, has long been under threat and has stopped fueling bullish sentiments. Financial conditions for business no longer look so attractive and bond yields are declining.


It should be noted that the pause in the normalization of rates will in no way will prevent the Fed from proceeding to the stage of reducing the balance. These are unrelated issues. This means that the Fed can already announce the launch date of the program at the next meeting. This step can lead to increased volatility and increased tension, but it is unlikely to increase bullish sentiment among players.

Negative sentiment is increasing as losses are calculated from Hurricane Harvey, which according to recent data, may reach $ 180 billion. Harvey is replaced by another hurricane, which has already been given the maximum degree of danger. This, of course, does not improve the mood of players.

Today, we should pay attention to the publication of the ISM business activity index in the service sector. For quite a long time, the growth of the sector was the main driver of the US economy growth, since it was in the service sector that the bulk of new jobs were created. In July, the index fell sharply from 57.4p to 53.9p. Another fall can contribute to the formation of a new wave of dollar sales.

On Thursday night, the head of the Federal Reserve Bank of New York, William Dudley, who is considered an influential member of the Cabinet will enter with his vision of the economic situation. Earlier, Dudley was of the opinion that employment growth would ultimately lead to an increase in inflation, so if the market sees that Dudley has changed his position, then dollar sales may take an avalanche-like character.

Currently, there is no need to wait for a turn in the mood for the dollar. The favorite is gold and the euro will take a break until Thursday.

The material has been provided by InstaForex Company -