The Canadian dollar dropped rapidly ahead of and then after the release of the Federal Open Market Committee minutes. USD/CAD was probing support at $1.3135, which proved to be formidable. Prices then bounced and the break above $1.3190, set the stage for further gains.
However, as long as prices stay below $1.3330, the rally is merely a correction.
Yesterday’s Canadian inflation data served to confirm suspicions that domestic interest rates will stay low for longer. July CPI rose 0.1% y/y, well below the 0.7% increase in June. The results were not unexpected as the Bank of Canada is on record saying inflation would be low for the foreseeable future.
The FOMC minutes from the July 29 meeting led to an outsized reaction in FX markets. Analysts were expected to see Committee members come out in favour of yield curve controls (YCC). That didn’t happen. It appears the FOMC is not a fan of that policy tool. They thought the benefits would be minimal and the costs excessive.
The minutes noted: "Of those participants who discussed this option, most judged that yield caps and targets would likely provide only modest benefits in the current environment, as the Committee’s forward guidance regarding the path of the federal funds rate already appeared highly credible and longer-term interest rates were already low."
They added "Many of these participants also pointed to potential costs associated with yield caps and targets. Among these costs, participants noted the possibility of an excessively rapid expansion of the balance sheet and difficulties in the design and communication of the conditions under which such a policy would be terminated, especially in conjunction with forward guidance regarding the policy rate."
The U.S. dollar rallied, in part because the minutes provided traders with an excuse to bank some profits as there were signs that the U.S. dollar was oversold. The extent of the U.S. dollar rally may have been exaggerated because of reduced liquidity in holiday-thinned markets.
The Canadian dollar sank alongside the U.S. dollar rally against the G-10 majors. AUD/USD selling was exacerbated because it was over-bought and China/Australia tensions escalated. China is expected to be very unhappy when the Australian government veto’s a Chinese Dairy’s $600 million plan to buy Australian dairy assets.
U.S. Philadelphia Fed Manufacturing Survey and weekly jobless claims are on tap today.
