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US Dollar May Rise Despite a Defensive Turn in Fed Guidance

TALKING POINTS – US DOLLAR, FOMC, FED, YEN, AUSSIE DOLLAR

  • US Dollar may rise despite a defensive turn in Fed policy guidance
  • Markets’ rate hike outlook unlikely to be altered by FOMC update
  • Cautious rhetoric may stoke global slowdown fears, sour sentiment

The US Dollar narrowly outperformed in generally quiet Asia Pacific trade. The tepid rise probably reflects corrective flows after the prior session’s modest drawdown, speaking to traders’ desire to rebalance exposure toward neutral ahead of the much-anticipated FOMC monetary policy announcement.

Chair Powell and company are widely expected to keep the current policy mix unchanged. Meanwhile, the tenor of recent pronouncements from central bank officials suggests a downgrade of growth and inflation forecasts as well as a flattening of the projected rate hike path are almost certainly in the cards.

A DOVISH SURPRISE FROM THE FOMC IS UNLIKELY

That is probably not enough to sustain lasting directional development from financial markets. Investors’ priced-in view envisions no rate hikes in 2019. Even if the Fed were to erase the entire 50bps it envisioned in December – which seems improbably dramatic – that would still just meet existing expectations.

In practice, this means that a meaningfully market-moving dovish surprise will be very difficult to achieve unless the FOMC opts to formally introduce constraints on its $50 billion/month quantitative tightening (QT) program. That too seems unlikely given how little airtime has been used to set the stage for it.

On the other hand, the markets have found it entirely appropriate to operate in defiance of the Fed’s official forecasts since the beginning of the year. This implies that they may not rush to reprice a 2019 rate hike into what is the current conventional wisdom even if the Fed retains one increase in its game plan.

FED FORECAST UPDATE MAY SOUR MARKET MOOD

In all, that seems to lead to the conclusion that the announcement won’t markedly alter the status quo for prevailing US monetary policy bets one way or the other. Officials’ more timid view might stoke already swirling global slowdown fears however, souring investors’ mood.

That may boost the US Dollaras de-risking puts a premium on liquidity while the unwinding of carry trades offers a lift to the Japanese Yen. At the other end of the G10 FX spectrum, the sentiment-geared Australian, Canadian and New Zealand Dollars might find themselves bearing the brunt of selling pressure.

What are we trading? See the DailyFX team’s top trade ideas for 2019 and find out!

CHART OF THE DAY – US DOLLAR HOLDS UP DESPITE COLLAPSING RATE HIKE BETS

US Dollar May Rise Despite a Defensive Turn in Fed Guidance

Conventional wisdom tells us that deteriorating rate hike bets ought to sink the relevant currency. In most cases, this is an entirely reasonable expectation. The Greenback has clearly shown a capacity to behave otherwise since late 2018. Collapsing Fed rate hike expectations seemed to cap gains but a parallel downturn has not followed. That seems to put USD’s haven appeal on full display and make plain the possibility that with sufficient risk aversion, it can be well-supported even as policy support evaporates.

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— Written by Ilya Spivak, Currency Strategist for DailyFX.com

To contact Ilya, use the comments section below or @IlyaSpivak on Twitter

Source: dailyfx.com