Divided Fed keeps markets directionless

6 July, 2017

Minutes from the Federal Reserve’s meeting on 13-14 June showed that monetary policy members were split over the timing of shrinking the balance sheet. While some Fed officials want to kick off the process for reducing the holdings of treasuries and asset-backed securities in September, others want to see more clues on inflation, which has been edging lower. These mixed signals have kept the bulls and bears on the sidelines and that is why it is not surprising to see a muted market reaction.

While U.S. Treasury yields declined slightly, they are still trading at multi-week highs, providing little incentive to short the U.S. dollar. Traders are still awaiting Friday’s Labor Report for fresh signals on the health of the U.S. job market. I think this report will be of more importance than the released minutes and will be a critical test to the U.S. currency. While charts are still indicating oversold signals on the USD, it will require a fundamental catalyst to convince bulls to return. The 138,000 jobs added to the economy in May came sharply below the expected increase of 185,000. Wage growth also disappointed, with average earnings rising 2.5% annually. If the NFP report managed to surprise by moving to the upside on Friday, the USD will likely find a near-term bottom. However, the headline figure would not be enough, even if it came above 180,000. Wage growth is what’s needed to narrow the gap between the Fed’s dot plot and the markets own dot plot. Today’s agenda includes the ISM Non-Manufacturing report and ADP Employment Change; if these report more robust figures, they could provide fresh support to the USD.

Oil prices made most of the headlines yesterday after declining more than 4%. The steep fall occurred after an eight-session rally, but thanks to the American Petroleum Institute report on Wednesday, which showed a huge drop of 5.8 million barrels in crude supplies, an end was put to the steep fall. Today’s EIA Report will likely confirm that inventories declined last week by more than 2 million barrels. Overall, one report is not enough to generate a bullish market sentiment. It requires steady declines in inventories along with a drop in drilling activities.  Traders will also keep a close eye on Libya’s and Nigeria’s production, which accounted for half of OPEC’s production increase in June. Given that nothing has changed fundamentally this week and yesterday’s selloff looks mostly technical, I believe prices will stabilize for the rest of the week.   

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