No Fed's Hikes This Year: USD Decline In The Making - Morgan Stanley

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Weak US data... Following the release of the US non-manufacturing ISM falling to its weakest level since 2010, US rate expectations and USD have fallen. However, the Exhibit below illustrates that rate expectations adjusted less than USD, which makes sense, given that the Fed's current strong rhetoric is almost providing calendar guidance towards higher rates. Similar to last autumn when the Fed prepared markets for a rate hike, even when the economy was weakening, it seems to be going ahead with its rate hike plans. Overnight comments by the Fed's Williams making clear that September remains a live meeting adds to this impression.

...suggests slow adjustment of rates: With US rates trading only reluctantly lower, USD's fall against low-yielding FX has been slower, but against highyielding currencies, the USD retreat is in full swing. While the weak US data may not stop the Fed from hiking – as illustrated last year – it may suggest a very slow adjustment of rates. This time is different from last year when the Fed's dots predicted that the Fed would follow the December hike with four more 25bp steps in 2016 and the market was pricing in two to three rate adjustments.

Fed communication and USD decline: Anyhow, our economists suggest that the Fed will not hike at all this year as the US economy is expected to slow down from here. For the rates market to adjust accordingly, it may require the Fed to change its language, which has not happened yet as Williams illustrated overnight.

Once the Fed adjusts its communication, USD should fall against the low-yielders with similar pace as it is currently falling against high-yielders.


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