The latest meeting minutes from the Federal Open Market Committee (FOMC) held a surprise for GBP USD traders.
GBP USD exchange rates are modestly higher than before the minutes were released, trading in the region of 1.24.
The accounts revealed extensive discussion of policy regarding the Federal Reserve’s enormous US$4.5 trillion balance sheet, which markets had not been expecting for several months yet.
‘Participants agreed that reductions in the Federal Reserve’s securities holdings should be gradual and predictable, and accomplished primarily by phasing out reinvestments of principal received from those holdings,’ the minutes read.
Ceasing reinvestments would mean that a maturing asset is not replaced, freeing up capital and reducing the size of the balance sheet.
Further interest rate hikes throughout the year were hinted at.
‘Provided that the economy continued to perform about as expected, most participants anticipated that gradual increases in the federal funds rate would continue,’ the minutes stated, meaning that policymakers believe ‘a change to the Committee’s reinvestment policy would likely be appropriate later this year.’
However, the minutes actually pushed GBP USD exchange rates higher.
Shrinking the balance sheet would lower demand for US treasuries, which in turn would raise the interest rate lenders would need to offer in order to entice investors.
With companies and government having to pay more interest to investors in order to borrow money, the Federal Reserve might deem it appropriate to pause the pace of monetary policy normalisation and keep the Federal funds rate low to offset the impact caused by indirectly flooding the market with treasuries.
So, while the FOMC minutes contained plenty of new information for investors to digest, it has done little to change the ultimate problem keeping the US Dollar soft at present; uncertainty.
With the outlook on Fed policy remaining cloudy and no signs on when, or indeed if, President Donald Trump will be able to enact his enormous stimulus plans, investors still have little reason to buy or hold the US Dollar.
This puts the Pound in a position of strength, helping build upon demand triggered after yesterday’s UK services PMI showed an unexpectedly strong pace of sector growth.
Predicted to inch up from 53.3 to 53.5, the index instead climbed to 55, which helped push the composite reading to 54.9 instead of stagnating at 53.8.
However, GBP gains have been curbed by the realisation that the latest PMI changes little about the economic outlook for the first-quarter of 2017; GDP is still likely to have slowed, with IHS Markit’s Chief Business Economist Chris Williamson expecting the pace of expansion to have weakened from 0.7% at the end of 2016 to 0.4% in the three months to February.
Additionally, Williamson believes the strong data will not alter the path of monetary policy, commenting;
‘The March uptick in the PMI surveys merely brings the data in line with a neutral policy stance at the Bank of England. As such, the data add to the sense that, with economic and political uncertainty likely to intensify as the Brexit process gets underway, policymakers are likely to continue to stress the need to look through any further upturn in inflation and focus instead on the need to keep policy on hold to support economic growth.’
This leaves investors awaiting the next Bank of England (BoE) monetary policy meeting and the next UK GDP figures.
For the US, news of Trump’s stimulus plans and further clarity on the pace of monetary normalisation are vital.
GBP USD exchange rates could therefore be in for choppy trading in a narrow range until someone or something provides some clarity.
At the time of writing the GBP USD exchange rate was trending in the region of 1.24, while the USD GBP exchange rate was trading around 0.80.
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