As long as the Fed keeps up the hawkish rhetoric, the dollar will continue to dominate. That’s the view of 53 currency strategists polled by Reuters.
And the dollar HAS been tearing things up lately with the dollar index (DXY) knocking on the door of 100:
St Louis Fed President James Bullard said yesterday that the Fed is behind the curve which is why he sees interest rates at 3.5% by the end of 2022. Bullard represents the more hawkish end of the spectrum.
However, while his colleagues generally see the need to bring rates back to ‘neutral’ (estimated at around 2.4%) as soon as possible, there are signs that the hawkish Fed has set a very high bar to surprise markets now.
Recent Fed commentary and the minutes from the last meeting strongly suggest that a 50bps hike and the start of Quantitative Tightening are likely at the May meeting. Which begs the question…
Could the May meeting represent peak Fed hawkishness?
Yesterday, Bostic said:
"It's time that we get off of our emergency stance -- I think it's really appropriate that we move our policy closer to a neutral position -- but I think we need to do it in a measured way,"
Evans said:
"I'm optimistic that we can get to neutral, look around, and find that we're not necessarily that far from where we need to go."
Whether the Fed decides to go “beyond neutral” or merely “back to neutral” is still a very open question for markets and likely depends on how the data evolves from here. .
As for the USD, it’s always a relative game. Plenty of digital ink has been spilt over the fate of the euro given the potential for energy price spikes to push the eurozone economy into stagflation or even recession.
And there’s been no let up in the EURUSD downtrend:
Each time the pair has looked likely to break higher, USD strength has returned and sent EURUSD down once again.
Fundamentally, the economic situation is just one of the factors to consider. There’s also the French election over the next few weeks, with Marine Le Pen’s late surge in the polls turning a few heads. “Political risk” has started to reappear in a few strategist forecasts.
Interestingly, EURUSD is trading right back at the Macron 2017 election levels. Could a Macron victory see a repeat of the post-election rally?
Then there’s the ECB meeting on April 14th. Interest rate differentials matter, and they’re currently widening. In the US, the Fed is cracking on with rate hikes and QT. The ECB has only just moved the debate on from when to end QE, and there’s no clear consensus for rate hikes as yet.
However, money markets are pricing in a rate hike for September, followed by another hike to return interest rates to zero before the end of the year.
Goldman Sachs economists expect a 25bps hike at both the September & December meetings.
It’s by no means a done deal, but if the market starts to believe in a more hawkish (or less dovish) ECB just as the Fed reaches peak hawkishness, perhaps this could finally see the pair buck the trend?
Not investment advice. Past performance does not guarantee or predict future performance.
