Fed and ECB return focus to monetary policy divergences

The FOMC statement, yesterday, renewed expectations for a US rate lift-off in December and lifted the USD higher. The Fed removed the reference of global economic and financial developments restraining economic activities and keeping downward pressure on inflation in the near term. This was the phrase that markets used to push out Fed hike expectations into 2016.

Even so, the market will need upside surprises in tonight's advance estimate for 3Q15 GDP and tomorrow's PCE deflators for Sep15 to increase its conviction here. As long as the door is open for a Fed hike in December, comments from Fed officials will no longer be ignored. Fed Presidents John Williams (San Francisco) and Esther George (Kansas), who support rate hikes in 2015, will be speaking tomorrow.

With the European Central Bank (ECB) now contemplating more quantitative easing, the theme is returning to monetary policy divergences. China cut its lending/deposit rates and lowered its reserve requirement ratio last Friday. USD/ CNY will probably be thinking about following USD/CNH back to 6.40. On the other hand, USD/JPY is still reluctant to deviate far from 120, unconvinced that the Bank of Japan may deliver fresh stimulus at its meeting tomorrow. Japan's policymakers appear keen for the US rate hike, when it eventually comes, to lift the USD against the JPY.

The DXY (USD) index still needs to break above the 93-98 range that it has been trapped in since Apr 2015. Given the return of monetary policy divergences, this is no longer a remote possibility. The euro accounts for 57.6% of the weights in the DXY. A higher DXY above 98 would also imply a lower EUR/USD below 1.08. That said, policy actions are not imminent. The ECB will only deliver, on 3 Dec, its verdict on whether it needs to do more to achieve its inflation target. On the same day, Fed Chair Janet Yellen will need to tell the Joint Economic Committee if the Fed is still on track to hiking this year. The USD's uptrend may still be bumpy yet.