Article / 27 July 2017 at 2:24 GMT

Declining USD sowing the seeds of its own revival

Managing Director / Technical Research Limited
New Zealand
  • A weakening USD is good news for the Fed, as it will help boost inflation
  • An update of the Fed's preferred inflation data is due out next week
  • AUD and NZD benefit from USD weakness, despite dormant inflation downunder
By Max McKegg

A falling USD might have been expected to give the Federal Open Market Committee increased confidence that its 2% inflation objective could be achieved sooner rather than later, but there was no evidence of that in the monetary policy statement released on Wednesday. Instead, members expect inflation to remain “somewhat below” 2% in the near term. They will be “monitoring inflation developments closely”, a subtle hint of concern perhaps that “somewhat” below 2% could develop into “significantly” below.

An update on the Committee’s preferred inflation measure, the price index of personal consumption expenditures (PCE) is due next Tuesday.


While the FOMC expects inflation to stay "somewhat below" its targeted 2% rate for now, the weaker US dollar could help push up prices. Photo: Shutterstock

The FOMC’s lack of confidence gave FX and fixed income traders cause to pull USD and bond yields down. The line in the statement saying the Committee expects to begin implementing its balance sheet normalization program “relatively soon” had little impact.

Three rounds of QE have seen the Fed’s balance sheet rise to $4.5 trillion and the plan is to cut it in half over a two to three year period.


Source: Bloomberg

Know when to hold ‘em; know when to fold ‘em

One would expect talk of a withdrawal of buying support for the US bond market would be putting upward pressure on yields but, so far at least, that’s not the case, probably because the Fed’s balance sheet size is matched by that of the Bank of Japan and European Central Bank (with the Bank of England contributing a bit on top).

In a global market place, relativities matter, and US yields won’t rise in isolation. The Fed might be looking at folding, but the others are holding.
Central bank balance sheets

Source: Financial Times

AUD and NZD have become the main beneficiaries of USD weakness, despite the fact that inflation is dormant down under as well. The June quarter inflation update out of Australia showed the headline rate at just 1.9%, back under the 2%-3% target band, while the core number held steady at 1.8%.

That doesn’t seem to be any cause for concern at the Reserve Bank of Australia. In a speech on Wednesday, RBA governor Philip Lowe commented: "We have not sought to stimulate a rapid lift in inflation. The fact that the labour market has been generating sufficient jobs to keep the unemployment rate broadly steady has allowed us to be patient."

Lowe said that "our judgement has been that seeking a more rapid pick-up in inflation through yet further monetary stimulus was likely to add to the medium-term risks. Our central scenario remains for underlying inflation to pick up gradually as the economy strengthens."
Australia's inflation trend


Source: Westpac

Those RBA comments sound like a recipe for an unchanged policy rate (1.5%) for the remainder of this year and probably 2018 as well. This could put downward pressure on AUDUSD as the interest rate differential will move in favour of the USD for the first time in two decades, assuming the Fed sticks to its guns and hikes once more before year end and three times in 2018.

A similar situation applies in New Zealand where the central’s banks preferred measure of core inflation is holding steady around 1.5% and showing no signs of budging. Noise around the headline rate caused by energy and food price fluctuations might get the markets excited from time to time, but in all likelihood the policy rate in New Zealand (1.75%) will be held steady through 2018 as well.

New Zealand inflation


Source: Reserve Bank of New Zealand

The Swiss National Bank is not showing any signs of changing its policy rate either. A setting of – 0.75% on its own is not deterring foreign capital inflow or encouraging Swiss capital outflow leaving the exchange rate  “significantly overvalued” according to the bank’s assessment and requiring persistent intervention in the FX markets to hold it down.

Unlike other central banks conducting QE, the Swiss are not active in the local bond market and medium to long term yields are set by market forces. Recently, after a long period in negative territory, the return on the 10-year confederation bond has put its head back up above zero
Swiss 10 year government bond yield


Source: Wall Street Journal

A weakening USD will be good news for the Federal Reserve as it will increase input prices and give a modest boost to inflation. Other central banks will be worried out negative fallout in their own jurisdictions as export receipts in local currency terms decline, acting as a drag on national incomes, and lower input prices further delay a return to inflation targets.

Interest rate hikes will be off the agenda again, leaving the stage to the Fed. The net result might be that this period of USD weakness is sowing the seeds of its own revival.

For more on forex, click here.

– Edited by Robert Ryan

Max McKegg is managing director of Technical Research Limited. Follow Max here or post your comment below to engage with Saxo Bank's social trading platform.

Patto Patto
Just goes to show there are no "iron laws" for traders in the FX markets. Speculator positioning (long) in NZDUSD is at mutli-year highs and yet still the Kiwi powers on, burning shorts in the process. Trading against the herd can be a costly strategy.
Max McKegg Max McKegg
Well said Patto


The Saxo Bank Group entities each provide execution-only service and access to permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on or as a result of the use of the Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. When trading through your contracting Saxo Bank Group entity will be the counterparty to any trading entered into by you. does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of ourtrading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws. Please read our disclaimers:
- Notification on Non-Independent Invetment Research
- Full disclaimer

Check your inbox for a mail from us to fully activate your profile. No mail? Have us re-send your verification mail