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.
Key Quotes
“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.”
