(17 JULY 2017)DAILY MARKET BRIEF 2:US dollar to weaken, as Fed aims to let inflation run and keep interest rates low

The US Federal Reserve wants to let inflation run and keep interest rates low. This, we believe, is for two reasons. First, letting inflation rise will allow erode the US Central Bank’s bond-bloated balance sheet in real terms. Second, hiking interest rates above 2% would trigger a major recession and push debt-service payments to an unsustainable level. (The current Federal Funds rate is 1.16%.)

So at the next meeting of the Fed’s Open Market Committee, on 25-26 July, we believe interest rates will not be increased. This will weaken the USD against the EUR, hiking it to $1.15 for 1 Euro in the short term.

Last week, in testimony to the US Congress, Fed Chairwoman Janet Yellen admitted that stocks markets are overheated, and that strong “valuation pressures” prevail across a range of assets. Nonetheless, Yellen was unclear whether interest rates will rise before year-end. Her stance is a marked departure from policy of the preceding eight years, when the Fed repeatedly boosted stocks through liquidity and verbal interventions.

By Yann Quelenn