Goldman Sachs 'Long' Dollars Ahead of Federal Reserve Decision

• Fed to push up projections for peak interest rates
• Overall, supportive of USD
• Maintains a bearish stance on GBP

Above: A view of the Goldman Sachs stall on the floor of the New York Stock Exchange. REUTERS/Brendan McDermid/File Photo.

Analysts at Goldman Sachs are 'long' the Dollar ahead of the midweek Federal Reserve policy decision as they look for the central bank to raise projections for the expected peak in interest rates.

Money market pricing signals investors are well prepared for a 50 basis point hike in the Federal Funds Rate, ensuring it will be left to the updated projections and guidance from the Federal Reserve to trigger financial market volatility.

"The main event at the December FOMC meeting is likely to be an increase in the projected peak for the funds rate in 2023," says Jan Hatzius, Head of Global Investment Research Division & Chief Economist at Goldman Sachs.

Goldman Sachs expects the median dot to rise 50bp to a new peak of 5-5.25%.

"Fed officials had hoped that pairing a slower pace of tightening with a higher terminal rate would prevent a large easing in financial conditions. That plan has not worked," says Hatzius.

The easing in financial conditions - i.e. the cost of money is now cheaper than it was a few weeks back - is due in part to November's softer inflation report.

This led investors to bet the Fed was entering the tail end of its hiking cycle, allowing them to price in a time of steady, and then falling, interest rates.

Goldman Sachs' financial conditions index has now eased by about 100bp from its recent peak and their estimate of the drag on growth in 2023 from the tightening in financial conditions has shrunk meaningfully.

This leads economists at the Wall Street bank to worry U.S. economic growth might prove more resilient in early 2023, thereby stimulating domestic inflationary pressures.

But Hatzius says there is not much the Fed can do to push back against the recent easing in financial conditions short of signalling another 50bp hike in February.

"The recent easing might seem like less of a problem to the FOMC than it does to us because most other forecasters expect a recession next year, in part because they expect the impact of the rate hikes so far to be more lagged than we do," says Hatzius.

As such, aside from the increase in the terminal rate projections, Goldman Sachs does not expect major changes at the December meeting.

At some point in the future economists expect the FOMC's statement to be revised to say that "further" rather than "ongoing" rate hikes are appropriate, but not yet.

This would be tacit confirmation that the end of the cycle is in sight.

Regarding the updated economic forecasts, Goldman Sachs looks for less growth next year, but a broadly similar outlook.

The dot plot is likely to show slightly larger cuts beyond 2023 from the new higher peak.

Goldman Sachs continues to expect three 25bp hikes in 2023 to a peak of 5-5.25%, though the risks are tilted toward 50bp in February.

From a currency perspective, strategists at Goldman Sachs are looking for Dollar strength.

"Considering our view that US growth will prove resilient, and the FOMC will at least want to avoid further easing, we think investors should position for hawkish news on net in the near-term," says Kamakshya Trivedi, co-head of Global Foreign Exchange Research at Goldman Sachs.

Goldman Sachs currency strategists are 'long' the Dollar against the Yen heading into the Fed decision.

The investment bank also maintains a bearish stance on the Pound despite recent outperformance as analysts continue to think that a lack of support from higher real rates will eventually limit currency strength.

Part of the justification for the stance is the expectation the Bank of England will continue to shy away from hiking interest rates to the extent required to bring down elevated inflation levels.

The UK central bank is expected to limit rate hikes in order to protect economic growth.

"Without tighter policy to dampen underlying core inflation pressures, Sterling is likely to remain the key adjustment mechanism in the economy, and with positioning-driven appreciation likely having run its course, the currency is likely to see additional underperformance," says strategist Michael Cahill.