USD: Is it different this time? – Rabobank

Jane Foley, Research Analyst at Rabobank, notes that the FOMC yesterday indicated that it is expecting to hike interest rates three times during the course of 2017 and in addition three more rate hikes have been pencilled in for both 2018 and 2019. 

Key Quotes

“The Fed have signalled that the US labour market is nearing full employment and that inflation is moving rapidly towards targeted levels.  The DXY dollar index lurched higher on the news and EUR/USD dropped down to the 1.05 area.  On the back of the hawkish sentiments from the Fed and the market’s current belief in Trump’s reflationary policies we are revising up our USD forecasts.  However, we remain sceptical of whether the Fed will be able to fulfil its promise of three rate hikes next year and thus we see risk of the USD slipping back from the middle of the New Year.”  

“We have been consistently more dovish then the market in our Fed calls.  As was the case for both 2015 and 2016 we expect the Fed to only hike rates once in 2017 and this reasoning is based on several factors.”

“Currently the market is concerned about the inflationary consequences of more fiscal spending on an economy already operating at close to full capacity.  However, there is often an implementation lag following decisions on infrastructure spending.” 

“In addition to this we are concerned about the negative impact to growth from Trump’s protectionist stance on trade.  Also, relevant is that the current makeup of the FOMC will change.  Due to the Fed’s rotating vote system, next year September’s three hawkish dissenters George, Mester and Rosengren are due to lose their votes.  This implies that a more dovish FOMC could result.”  

“Even if our more-dovish-than-the market view is once again correct in 2017, it will take some time to prove.  Following the Fed’s hawkish projections in December 2015, the market progressively extended its USD long positions well into the spring of 2016.  By the middle of the year, however, USD longs were being unwound.  We see risk that a similar pattern could develop in 2017.   Optimism about Trump’s fiscal plans could keep the USD underpinned in the initial months of the year and a more moderate reality could counter enthusiasm for the USD from the middle of 2017.  On the back of this view, we have revised up our forecasts for USD/JPY to 120 on a 6 month view, tapering back towards 115 in 12 mths.”  

“Layered on top of the uncertainties connected with Trump’s policies are those connected with European politics.  The potential for Italian elections to be brought forward from 2018 adds another potential source of volatility to a timetable that already has Dutch, French and German election scheduled.  Although there is considerable risk that all of these elections will see increased support for the far-right/populist parties, polls indicate that support will be insufficient for a nationalist government to be formed in any of these countries.  Consequently we see scope for the EUR to end 2017 a little more emboldened than it is currently.  As a result, we continue to forecast that EUR/USD will avoid plunging below parity in 2017.  In acknowledgement that politics is a significant risk for the EUR, we have revised lower our 3 mth EUR/USD view to 1.03.  However, we have kept our 12 mth forecast at EUR/USD1.10.”