US Dollar Plummets as FOMC Meeting Minutes Show Potential for Expanded QE, Downgraded Growth Forecasts

The US dollar took a heavy hit on Wednesday, falling close to 2 percent against the British pound and tumbling over 1 percent versus the Canadian dollar, Japanese yen, and euro, suggesting that the currency has lost its link with risk trends. Indeed, US equities spent part of the day in positive territory but the S&P 500 subsequently ended the NY trading session down 0.5 percent.

Looking to the big US event risk for the day, the release of the minutes from the Federal Open Market Committee’s (FOMC) April meeting shed a bit more light on their policy bias. After the Federal Reserve’s last meeting, the markets saw no surprises as they left the fed funds target range at 0.0 percent - 0.25 percent and said that “conditions are likely to warrant exceptionally low levels...for an extended period.” Furthermore, the FOMC reiterated measures first announced in March, when they said they would still purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year, as well as $300 billion of Treasury securities by autumn.

However, according to the minutes, some members noted that a further increase in the total amount of asset purchases may be needed later on in order “to spur a more rapid pace of recovery,” though all members wanted to wait and see how economic and financial market conditions progress. Meanwhile, the FOMC’s quarterly economic forecasts were revised, as the Committee now expects that a deeper recession in 2009, a slower rebound in 2010, a greater rise in unemployment, and a slight increase in prices.

Japanese Yen Gains as 15.2% Contraction in Q1 GDP Proves To Be Better Than Expected

An interesting thing happened in the FX markets on Tuesday night: the Japanese yen gained following better-than-expected Japanese economic data. Though Japan’s economy shrank by a record 15.2 percent in Q1 from a year earlier, the decline was not as severe as projected since Bloomberg News was calling for a 16.1 percent contraction. The drop was led by falling private demand, as consumption declined further and businesses cut back on investment. Furthermore, exports plunged by a record as the Japanese yen held strong and the economies of Japan’s biggest trade partners slowed or fell deeper into recession. All told, there’s little in the way of positive news reflected in this report, but in the FX markets, everything is relative. The bigger factor here was that the Japanese yen didn’t necessarily respond to risk trends, and as a result, leaves Japanese fundamental reports as a key thing to watch going forward.

Euro, British Pound Rocket Through Key Resistance Levels, BOE Minutes Reveal Few Surprises

The euro and British pound rocketed higher on Wednesday, as EUR/USD broke above the March and May highs of 1.3723/40 while GBP/USD pushed above a rising channel formation that had contained price since April to six-month highs near 1.5800. Meanwhile, EUR/GBP fell below its short-lived range of 0.8800-0.9025, though the next levels of support loom close by at 0.8726 (the 2/24 low) and 0.8662 (the 200 SMA). Looking at event risk from the Euro-zone and UK, it was clear that none of them had much of an impact on the FX markets. German producer prices plunged 1.4 percent in April, pushing the annual rate down to -2.7 percent, suggesting that if there are any inflation risks for the Euro-zone, they are more heavily weighted to the downside.

From the UK, the minutes from the Bank of England's May 7 meeting weren’t as market-moving as they've been in the past, as there has already been significant detail revealed about the mindset of the Monetary Policy Committee (MPC). We already knew that the BOE decided to expand their quantitative easing (QE) program by 50 billion pounds to 125 billion pounds (which happened to be by a unanimous vote), that the drop in Q1 GDP of -1.9 percent was worse than expected, and that CPI will likely will be below the BOE’s 2 percent inflation target in the medium term. While the minutes did reveal that some members thought that “a case could be made for a larger stimulus,” the high uncertainty of QE led them to believe that there was “no pressing need for the larger extension” at that point.

Canadian Dollar Breaks to 7-Month Highs vs. the US Dollar Despite Drop in Canadian CPI to 14-Year Low

The Canadian dollar surged against the greenback, pushing USD/CAD below key support at 1.1500, despite the fact that headline Canadian inflation fell to a more than 14-year low. On a monthly basis, CPI surprisingly fell 0.1 percent in April while the annual rate dropped to 0.4 percent, the lowest since December 1994. However, the decline was due primarily to weaker energy prices as core CPI – which excludes volatile items – rose 0.1 percent, leaving the annual rate at 1.8 percent, down from 2.0 percent.

According to the Bank of Canada’s last Monetary Policy Report in April, the Bank is open to quantitative easing (QE) and credit easing if nominal interest rates start to fall below zero. The Bank stated that while they could cut rates to zero in theory, it would ultimately "eliminate the incentive for lenders and borrowers to transact in markets, especially in the repo market." As a result, inflation reports will be key to gauging whether the Bank of Canada will go the route of QE in the future, but with core levels of inflation holding at fairly robust levels, the risks remain pretty low.

Terri Belkas is a Currency Strategist at FXCM.