USD: The Fed’s FX balancing act - Rabobank

Jane Foley, Research Analyst at Rabobank, expects that the Fed and the US Treasury will be wary about the risks associated with another lurch higher in the USD going into 2017 which could have an influence on the tone that the Fed chooses to set during today’s policy statement.  

Key Quotes

“USD bulls are currently excited by the prospect of a Trump-led surge in fiscal spending stimulating an economy already operating at close to full capacity.  US inflation expectations and measures such as PCE inflation have pitched higher in recent months and a moderately stronger currency could be useful in dampening price pressures.  However, despite the improvement in the US labour market, wage pressures remain contained.  In November US hourly earnings unexpected dropped -0.1% m/m leaving the annual rate of gain at 2.5% y/y, well below levels that would usually be associated with this point of the economic cycle.”

“While we fully anticipate that the Fed will announce a 25 bp rate hike following this week’s FOMC meeting, we expect the Fed to be cautious about hiking too far and too fast.  It is possible that the Fed may currently see a need to temper the spirit of USD bulls, in any case we anticipate that contained wage pressures in the US will contribute to the Fed eventually hiking rates only once during the course of next year. In this scenario, 2017 could unfurl in a similar way to 2015 and most of 2016 with enthusiasm for long USD positions running out of steam.”  

“In addition to the tone taken by the Fed this week, forthcoming US inflation indicators will be crucial for prompting the vitality of the USD going forward.  As it stands we are cautious about the outlook for the USD and see scope for a move higher in EUR/USD towards 1.08 on a 3 mth view.”