Less Dovish Fed Sends Yields, Dollar Higher

NEW YORK (BBH FX Strategy) -- The U.S. dollar is trading broadly higher in response to the less dovish Fed. The yen is the exception.

The rise in U.S. Treasury yields has led to a shakeout of positioning, with stocks declining. The FOMC minutes underscored that further policy easing would require a loss of economic momentum or a sharp drop in inflation. It appears to be a less dovish message than that delivered by Bernanke in last week's speech. On the growth outlook, the committee's views were more upbeat, as the Fed staff upgraded its near-term forecasts "a little."

Yet most members did not interpret the recent developments as a catalyst to upgrade their 2013-to-2014 outlook. Furthermore, the FOMC staff trimmed its estimate of the level of the potential output gap. This suggests that the FOMC estimates a lower level of "slack" in the economy. However, the minutes showed that significant downside risks to economic activity persist even though the strains in the financial markets have eased since January.

The Federal Reserve

The Fed also cited other risks to the economic outlook, including fiscal tightening, Europe-related risk, a slower recovery of the housing market, and deleveraging. In short, while the minutes show that the Fed is comfortable with its current policy stance and future rate guidance, it continues to reinforce our view that there will be no QE3 in Q2.

The European Central Bank has much to chew on Wednesday and it should be more evident in the press conference than the statement, which is no doubt going to leave rates unchanged.

The eurozone March purchasing managers' index remains below the 50 boom/bust level. Unlike the manufacturing PMI, the service measure was a bit better than the flash reading at 49.2 compared with 48.7 and it is even slightly better than the 48.8 in February.

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The stabilization of the regional economy that the ECB had pointed to appears at risk and the data is consistent with a further contraction of the eurozone economy in Q1. While the German reading of 52.1 is an improvement over the flash 51.0 reading, it is still down from 52.8 in February. Moreover, the German service sector is under-developed compared to its manufacturing sector and this has been a source of criticism from the European Commission. Germany, like other countries, is reluctant to restructure. However, the weaker-than-expected factory orders warn that even German manufacturing has lost momentum.

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