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Will The Fed Tolerate A Stronger USD For Longer? – Credit Agricole.

Given that US financial conditions have tightened of late, investors will also want to know if the Fed will tolerate further tightening (eg, USD appreciation). The Fed should deliver a 25bp rate hike but may keep its economic and policy outlook little changed, opting to wait for more economic data and details on the upcoming Trump stimulus. At the same time, Yellen may signal willingness to tolerate further tightening in US financial conditions in view of the latest rebound in US inflation expectations and given the resilience of risk sentiment at home and abroad.

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Given the latest USD underperformance, the bigger surprise for the FX markets could be indications that the Fed would tolerate higher UST yields and a stronger USD for longer, as well as any potential revisions to the 2018 dot-plot to reflect the recent drop in the unemployment rate below the Fed’s NAIRU.

This could help USD regain some lost ground vs commodity and risk-correlated G10 currencies if further tightening in global conditions starts eroding market risk sentiment. AUD could be vulnerable to potential disappointments from the upcoming data out of Australia and China. We keep open our short AUD/USD trade.*

The BoE, the SNB and the Norges Bank will also meet next week but should keep policy unchanged. That said, the MPC could see the latest disappointing UK data as confirmation of its cautious macro outlook and reiterate it will keep policy very accommodative in the face of surging cost–push inflation. This could keep the headwinds in place for GBP against USD. EUR/GBP could start consolidating after the recent sell-off following the Italian referendum and December ECB meeting.

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