U.S Dollar in the Wake of the Fed Decision: The Pro's Give Their Predictions

The Fed increased interest rates by a quarter of a percent on Wednesday, what do the leading analysts we follow make of the move and, importantly, the potential direction in future dollar moves?

It came as no surprise when the Fed increased interest rates by a quarter of a percent at its December rate meeting on Wednesday.

Many market-watchers had also been expecting the announcement to be accompanied by a dovish statement, and their expectations were met, as the Fed statement characterized the trajectory of tightening as “gradual” (and therefore slower than in previous cycles) - as well as heavily ‘data-dependent’.

Much ado about “Gradual”

In the post FOMC press conference Janet Yellen repeated the word “Gradual” 12 times to describe the pace of tightening and this was naturally pounced on by investors as significant, and followed by much debate about the word's precise definition in terms of monetary policy:

Bloomberg's Brendan Greeley, interpreted "Gradual" as meaning: “we are going to look at things, and we are going to wait to see what happens,” which he contrasted to “Measured,” which was the word the Fed used at the start of their previous tightening cycle during Alan Greenspan's tenure, and meant a more aggressive “step-like” increase, with a hike almost every meeting.

Also commenting on future pace, Laurence Mutkin, Chief Rates Strategist at BNP Paribas, whilst being interviewed on Bloomberg news, quipped: “She probably doesn’t mean you only have to show up every second meeting.”

He continued: “she made the distinction that gradual did not mean regular – however this left markets confused as we have 100bps of rises and 4 press conferences – which would seem to indicate a quarter percent rise per conference.”

Muskin dismissed the Fed’s ‘data-dependent’ criteria:

“She is keen to say that the path can change over time. The same was the case with the taper, the taper itself was supposed to be data-dependent but the truth was it carried on a very predictable and regular pace, and obviously that was because despite the changes in the day-to-day data the overall picture still matched the taper’s intent, and the same thing will happen here: if the data comes out roughly as they expect they will do as they expect.”

St George Economics, a division of the Australian banking group Westpac, interpreted “Gradual” as 100 basis points based on the Fed's own statement, but that this average was possibly skewed to the upside as the median was lower:

“The Fed’s interpretation of “Gradual” generally continues to be a total of 100 basis points of hikes in 2016.” The note goes on to say:

“That said, a fair amount of Fed officials (7 in total) expected less (either two or three 25 basis points) tightening next year, while 3 members expected more than the 100 bps. Given the past history of the Fed moving much more cautiously than expected, persistent low inflation and the strong US dollar, we remain comfortable with our view for three more 25 basis points rate hikes next year.”

Timing Right?

UniCredit’s Erik Nielsen, argued a rate rise 'sooner' would have been preferable to the Fed's 'later':

“By any measure of the data, (the Fed) are somewhat behind the curve.” 

Nor did he agree that inflation was too low to warrant a rise in the Fed Funds rate:

“If you clean up for temporary factors like healthcare, you see 2.0%, which is not consistent with 0.0% interest rates.”

It was important for the Fed to move now, because the effects of the rate rise would take 12-18 months to work their way into the economy.

On the problem of continued weak wage growth, Nielsen saw an improvement in labour market conditions pushing up future wage inflation, which despite being conspicuously absent now, was highly likely to emerge on the horizon.

BNP Paribas' Mutkin, said he thought Yellen had been “alright with the timing.”

Adding: “There is a spectrum of opinions and he Fed’s job is to move down the middle.”

He felt Core Inflation warranted a rise at it was now close to the Fed’s target.

Marc Faber, author of “Gloom, Boom and Doom,” was one of the voices calling for delay:

“The Fed rose rates at exactly the time when the global economy is slowing down.”

Gross calls Fed "Old Fashioned"

Meanwhile Bill Gross, the ‘Bond King’, formerly of Pimco and now of Janus Capital, thought the Fed had been “hawkish” and “old-fashioned” by ignoring modern deflation pressures:

“The Fed are living in an old age rather than the new age – of high leverage, reflective of globalised factors in terms of demographics – she (Janet Yellen) refuses to acknowledge these.”

Impact on the Dollar

After the announcement, the dollar rose marginally in most pairs, but was characterized as having change little overall.

Westpac’s Franulovich foresaw short-term dollar weakness, based predominantly on historical president:

“The USD of course tends to trade on the back-foot following the commencement of a hike cycle – falling in 4 out of the last 5 cycles,”

His research showed the dollar fell during the first 6-12 months in the tightening cycles which began in ’86. ’94 ’99 and ‘04.

ING Bank was more bullish about the outlook for the dollar, which they expected to move higher after “the dust settles,” :

“USD initially bounced around on this, but once the dust settles we expect it to grind higher – especially against the core low yielders such as EUR, JPY and CHF whose central banks will want to drive a wedge at the short end of the curve.”

The ING note went on:

“From what we’ve seen so far, we see no reason to change our year-end EUR/USD forecast of 1.05. Nor our 2Q16 forecast of 0.98.”

Putting it all into perspective

Strategist Kit Juckes, of Société Générale, pointed out sagely that the Fed rate hike may have been over-hyped, as other global concerns were now probably more important:

"The big problems outside the US remain in place. Commodity price overshoot, EM capital outflows, disorderly CNY adjustment, these remain threats to markets which dwarf whether the Fed moves rates too fast or to slowly.”