USD: Forward Guidance One Key Difference for Markets This Time – MUFG
Derek Halpenny, European Head of GMR at MUFG, notes that the US dollar is broadly stable today after weakening modestly yesterday as financial market conditions continue to provide justification for the Fed to take action either at the June meeting or certainly the July meeting.
“In fact, given Brexit concerns are a main reason for delaying beyond June, the continued conviction in the markets that the vote will be to stay is strengthening the case for June. That is certainly still not priced – the June federal funds rate has about a 16% probability of a rate hike at the meeting on 15th June.
The ‘Brexit’ effect appears to remain very influential and there is certainly logic in expecting increased nervousness amongst market participants ahead of the referendum on 23rd June. Fed Governor Powell in comments yesterday mentioned ‘Brexit’ risks as a factor “not to be in a hurry” but implied June was still certainly feasible.
But even if there is a notable shift toward June in the coming days and weeks, we do not expect it to have the same fallout for financial markets that took place in the run up to and beyond the first rate hike in December. Forward guidance we believe will play an important role in that. It is an entirely different scenario to hike with a message of four hikes per year in the future to hiking under guidance of there being just two hikes per year.
A hike every quarter forced the market to be more proactive in pricing the second hike immediately while a hike in June will allow the market ample time to ponder the likelihood of a second hike in December.
The data in the US is also helping. Today we get the second estimate for real GDP growth in Q4 that caused a lot of angst over the potential for a recession in the US. The Q1 real GDP estimate is set to be revised higher from just 0.5% to 1.0% - still weak of course but in the context of a rebound in Q2 is reassuring. The Atlanta Fed Tracker that we admittedly are somewhat dubious of, is pointing to a 2.9% Q/Q rebound in Q2. Such an outcome with the expected revision to Q1 GDP today would leave the economy roughly growing at the usual 2.0% growth rate that has clearly been ample enough to keep the unemployment rate trending lower. We shifted our FOMC call to July, but the longer the markets behave as they are now, the more likely it becomes that June might be the timing of the next hike.
The US dollar already looks weaker than it should be based on the traditional rate spread influence and the bias is still at this stage for the dollar to advance further versus the majors. A less volatile EM FX response than in December-February will further reinforce dollar gains versus the majors. Fed Chair Yellen will speak this evening (1815 BST) in Harvard but it appears unlikely that she will make any detailed comment in regard to the monetary policy outlook.”