Softer US dollar and lower FX volatility - MUFG

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Mar 21, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    Lee Hardman, Currency Analyst at MUFG, notes that the US dollar has continued to remain on a softer footing in the Asian trading session following the signal from the Fed last week that it plans to raise rates more gradually this year.

    Key Quotes

    “It has prompted the dollar index to fall back towards support from the bottom of the trading range which it has remained within for just over a year at around the 95.00-level. The Fed’s more dovish Fed policy signal has encouraged a further easing of FX volatility boosting the appeal of higher yielding currencies in the near-term as market conditions for carry trade strategies become more favourable.

    The Fed’s signal that it now only plans to raise rates twice this year has cast doubt on whether the next hike will be delivered as early as in June curtailing support for the US dollar in the near-term from the improving US economic data flow. US economic surprise indices have increased sharply over the last month with Goldman’s surprise index according to Bloomberg reaching its highest level since late in 2014.

    The University of Michigan’s survey of consumer confidence did not rebound as expected in March although it did not weaken materially either when the US equity market declined sharply earlier this year. It has remained elevated over the last year recording the strongest run of readings since the year up to the summer of 2005. The Fed will have been reassured that the University of Michigan survey measures of inflation expectations rebounded as well in March from cyclical lows in the previous month.

    Improving US economic developments should help to provide support for the US dollar making it unlikely that it will weaken much further. With the US interest rate market only pricing in one more hike this year and another for next year, the US dollar is already priced for a very dovish outlook for Fed policy in the coming years. The speculative market has already significantly scaled back long US dollar positions as well. The latest IMM report revealed that net long US dollar positions have been reduced by over three quarters since last year reaching their lowest level since July 2014 which was when the US dollar started to strengthen sharply. Further, it is likely that long speculative US dollar positions have been scaled back again following last week’s FOMC meeting moving closer to more neutral territory.

    Upcoming speeches from Richmond Fed President Lacker and Atlanta Fed President Lockhart will be in focus today for any further insight into Fed policy thinking although both are not voters on the FOMC this year. The market is still eagerly awaiting further insight into the Fed’s updated policy reaction function after it decided to halve the number of planned rate hikes for this year despite acknowledging that little had changed since December for the outlook for economic activity, inflation and the labour market.

    The comments on Friday from St Louis Fed President Bullard failed to provide further clarity. He stated that the US labour market is close to normal and that inflation net the oil shock is reasonably close to target. In light of these developments he stated that the Fed’s current accommodative policy stance remains extremely loose. However, he did not fully explain why rates should be only be “edged” to more normal levels.

    The Fed’s more dovish policy outlook does not appear fully consistent with their own forward guidance that policy is data dependent. It has added to uncertainty over the outlook for Fed policy and understandably increased market scepticism further over whether the Fed will follow through even with the more gradual planned rate hikes.

    If not fully justified by incoming economic data, the dovish policy shift is encouraging speculation that the Fed is willing to tolerate a period of higher inflation or is even more concerned by the risk of a more material economic slowdown, both of which are not captured in the Fed’s updated projections.”
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