Before Wednesday’s announcement by US Federal Reserve chair Janet Yellen that the bank’s long-held 6.5% jobless threshold for even considering hiking interest rates was to be discarded, the much-vaunted notion of the US dollar being on the verge of a new long-term trading uptrend seemed stymied in perpetuity.
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With US financial policymakers having linked stimulus to employment and inflation for the first time in December 2012, and the target for US overnight interest rates having been 0% to 0.25% since December 2008, the USD uptrend theory had instead been stuck in an environment where risk sentiment was not sufficiently buoyed by US growth to see inflows into US assets, but not sufficiently gloomy about an EM slowdown to see safe-haven inflows either, says Alan Ruskin, global head of G10 FX strategy at Deutsche Bank, in New York.
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| US Federal Reserve chair Janet Yellen |
It was not just the abandonment of the jobless threshold that has lifted the USD Index from its previous four-month lows but also Yellen’s accompanying comment that the timing of the first hike after the end of the current bond-buying programme could well be even earlier than anybody had expected.
Steven Englander, global head of G10 FX strategy for Citi, in New York, says: “The FOMC [Federal Open Market Committee] statement and forecasts contained unexpectedly hawkish elements, which Yellen didn’t dispel, with her clarification of the period between end-QE and rate being ‘considerable, so, you know, probably something on the order of around six months, that type of thing’.”
In practical terms, he adds, from an asset-market perspective, this would bring the first Fed rate hike into H1 2015 and possibly to late Q1, and this means that the market median forecast for rates at the end of 2015 had moved up to 1.00% from 0.75% in the December projections, and the median forecast for the end of 2016 had moved up to 2.25% from 1.75%.
“Whether this is what Yellen intended to say or not – as she repeatedly stated that FOMC policy had not changed – the markets have taken these comments to suggest a greater Fed willingness to tighten than had earlier been expressed, and frankly the USD could ask for nothing better than a stiffening of two years yields,” concludes Englander.
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Much of the timing for the Fed’s first post-QE hike will depend on the sustainability of the US’s economic upturn, but the omens here as well also seem propitious, says Jane Foley, senior FX strategist for Rabobank, in London.
“Yesterday also saw the release of the US’s Q4 2013 current-account deficit, which showed a fall to a better-than-expected $81.1 billion, the narrowest gap since Q3 1999 and, as a percentage of GDP, this represented the lowest ratio since Q3 1997 at 1.9%,” she adds.
Encouragingly as well for markets having been stuck in a near-zero interest rate policy (ZIRP) world for four years, was the fact there is recognition in the Fed it will need to move briskly on rate hikes once they have started – reflected in a range of expectations for 2016, but a higher average – says Kit Juckes, head of FX strategy for Société Générale, in London.
“The one-year US rate five-year forwards are a good way to gauge market expectations for FX and this has been in a 3.6% to 4.2% range since last autumn – a range consistent with the dollar moving sideways, FX vol falling and investors seeking out yield/carry,” he adds.
“But both the economic outlook and the Fed guidance seem to suggest that – while the range may not break soon – we are likely to meander upwards towards the top of it.”
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While the range holds, there is unlikely to be any notable follow-through of dollar strength across the board, but in the near-term, says Juckes, the two G10 currencies the dollar is likely to be strong against are the Canadian dollar (undermined by dovish Bank of Canada comments again this week, sensitive to US rates, and overvalued), and the yen (which should weaken as US rates edge up, particularly if the global risk environment remains broadly positive).
“GBP/USD and EUR/USD, on the other hand, will continue essentially to top out, with more significant moves down likely only later in the year when Fed hikes are much closer,” he concludes.
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Signs of a broader shift out of the current G10-yield malaise came last week, with the Reserve Bank of New Zealand (RBNZ) becoming the first of the G10 central banks to raise interest rates since the global financial crisis, and other central banks are expected to follow suit beginning in 2015, with the Bank of England perhaps next in the queue, says David Bloom, global head of FX strategy for HSBC, in London.
“Interest rate futures suggest the first UK hike may be delivered early in 2015, ahead of the Fed, and considerably ahead of any tightening by the ECB and, in a world where central banks will be trying to exit unprecedented monetary accommodation, the RBNZ experience will be closely followed.”
In this context, then, adds Bloom, should the tightening in New Zealand have unexpected and swift adverse effects, the RBNZ’s experience would be a potential prototype for others and in particular the BoE, showing that nascent economic recoveries should be allowed to progress further before the normalization of interest rates.
“Given the close association between UK rate expectations and the performance of GBP, a New Zealand-induced retreat in the market’s forecast of the BoE’s interest-rate path would see GBP sharply lower,” he concludes.