Hawkish Fed Shift to Offer More Support for the USD - MUFG
Lee Hardman, Currency Analyst at MUFG, notes that the foreign exchange
market has remained relatively stable overnight after absorbing the
shock from the strong signal sent by the Fed that it plans to resume
rate hikes soon.
“Comments yesterday from Fed Vice Chair Dudley confirmed that the Fed intended to prepare the market for a possible rate hike as early as at their next meeting in June. He stated that “if I’m convinced that my own forecast is on track, then I think a tightening in the summer, the June-July time frame, is a reasonable expectation”. His own outlook is for” an economy that grows above trend, continues to put downward pressure on the unemployment rate and leads to further tightening in labour markets, and causes us to become more confident over time that inflation is going to return to our 2 percent objective”. He confirmed that the Fed had intended to raise market expectations for further Fed tightening revealing that “there was a pretty strong sense” in the FOMC that markets were underestimating the likelihood of further tightening and that the range of views among officials was “relatively narrow”.
When assessing whether to raise rates in June, he signalled that the Fed will consider the “probability” of the UK voting to leave the EU. It implies to us that the Fed is willing to raise rates in June assuming that the perceived likelihood of Brexit remains relatively low as it currently stands. On balance, we still believe that the fed will err on the side of caution and wait until after the result of the referendum favouring a rate hike in July but we are certainly less confident in our view now.
For the performance of the US dollar whether the Fed resumes raising rates in June or July is unlikely to make a significant difference. The US interest rate market is still under-pricing the likelihood of further rate hikes this year leaving scope for US yields to move higher and supporting a stronger US dollar in the coming months. If the Fed resumes raising rates soon it will also re-energise monetary policy divergence trades boosting demand for the US dollar. There is scope for the speculative market to rebuild long US dollar positions after they were cut back sharply earlier this year.”