Near-Term Risk of USD Sell-Off on FOMC Tonight’s FOMC meeting could provide a short-term opportunity to short the USD against major G10 currencies (EUR, GBP, JPY, CAD). However, we remain structurally bullish on the USD in the medium term.
The risk for USD could come via two avenues: the external environment affecting domestic growth and/or inflationary expectations. Either could see the recent USD strength unwind.
The FOMC is likely to continue to highlight the improvement in the domestic economy. However the Fed has a dual mandate and either could prompt a downside move in USD.
If either are highlighted, the market is likely to push back expectations for a rate hike further into Q3/Q4. At the moment, expectations are for a rate hike in September.
The FOMC has already emphasised the gradual nature of any future tightening cycle and if it stresses a slowing growth or a softer jobs outlook due to problems abroad, it is likely to be reflected in more cautious language about the upcoming tightening cycle. A potential negative feedback loop from risks to growth in the rest of the world could come from many areas: increasingly divergent political situation in the Eurozone alongside moribund growth in the periphery and Japan, geopolitical risks or the impact of a stronger USD on corporate earnings.
The inflationary environment has been relatively benign despite improving economic activity. The FOMC previously noted the impact of lower oil prices on inflation would be transitory, so any indication that there could be longer lasting effects would see rate hike expectations unwound. Indeed oil prices were on of the reasons the Bank of Canada surprised the market by cutting rates. Meanwhile wage growth remains soft and house price growth has moderated recently. As a result, any indication that inflation may not return to target as quickly as expected could also postpone a rate hike from the Fed.
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