Concerns about global headwinds and asymmetric policy options are blowing strongly in the face of the FOMC’s desire to raise rates. But, since its March meeting, dovish comments from Fed officials have carried markets off course. Futures traders have now pushed back the timing of the next projected rate increase all the way to mid-2017, while at the same time net speculative positions on the US dollar index have fallen to their lowest level since June 2014. Together, that’s seen the dollar index depreciate almost 3% since the last FOMC meeting.
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But what is currently a headwind is likely to turn into a tailwind for the US dollar. The economy has continued to pump out jobs at an above-potential rate, with broader measures of slack finally approaching levels consistent with sustainable wage growth. So, while a June rate hike is no longer on the table, Fed officials should have enough evidence to inch rates up again by the end of summer.
Given the market’s pessimistic starting point, that will cause a broad repricing and drive the US dollar firmer one more time. Subsequently, however, the currency will face global headwinds of a different type.
As the year winds down, other developed economies will begin gaining speed as a result of past stimulus. With the US no longer standing out as the lone bright spot in the global economy, its trade deficit will be viewed in contrast with the surpluses seen in places like the euro area.
As a result, the US dollar will lose ground against a variety of its global counterparts heading into the end of this year and remain at those more subdued levels throughout 2017.