Brainard Rains On USD Bulls’ Parade

Fed’s Lael Brainard departed from the sentiments expressed by the majority of Fed members in comments made yesterday. Coming just days after the usually Dovish Rosengren argued in favor of a rate hike, noting that with US employment at full capacity and low rates risking an overheating of the economy, Brainard instead urged caution.

Brainard was the last Fed member scheduled to speak before the Fed meet next week for their September rate decision. As such, her speech was closely watched by traders keen to see whether the speech would see an extension of recent Fed Hawkishness. USD Bulls were left disappointed however as Brainard highlighted risks to the US economy, specifically from China and emerging markets.

Subdued inflation and uncertainty, both domestic and global, were noted as factors warranting caution in “the removal of policy accommodation.” Brainard’s comments fueled an instant unwinding in US September rate hike expectations which fell from highs of 30% on Friday to around 15% after her comments were made.

Fed Turning Hawkish Despite Data

Recently it seems the Fed has been seeking to guide markets in the direction of a rate hike this year despite recent data weakness and various global concerns such as Brexit and the upcoming US election. Traders now await key US data on Friday with August CPI due after Industrial and Manufacturing Production data on Thursday. Inflation data will be closely watched given recent weakness with May, June and July readings all falling short of expectations.

Premature Rate Move Poses Risks

The prospect of a Fed rate rise in the near term is challenging as many emerging market economies are still at risk. A rate rise would lead to a decline in the nominal GDP outlook alongside an increase in real US rates which would weigh on risk assets. The pace of deleveraging in economies with USD denominated debt is determined by the ratio of capital costs to return expectations. As global overcapacity has led to a weakening of return expectations, low funding costs are needed to upkeep a minimum expansion rate of fixed assets.