US: A final 2016 lift for the dollar, but could prove modest - MUFG

The final global macro event of a year that will be remembered for obvious reasons is upon us with the final FOMC monetary decision to be announced at 1900 GMT this evening suggests Derek Halpenny, European Head of GMR at MUFG.

Key Quotes

“Dollar gains have petered out so far this week and we see that as a sign of understandable reservations on running long dollar positions going into the announcement. The dollar on a DXY basis is currently 4% stronger since the end of the week prior to Donald Trump’s election victory fuelled by expectations of reflationary policies driving economic growth stronger next year.”

“But we do not expect much in the way of clarity on the economic outlook next year. Yes, we will get updates on forecasts with the “Summary of Economic Projections” released tonight but there will be no indication on how Trump will influence the outlook given how little we know in regard to the potential stimulus coming. So we expect only very modest alterations to the economic projections while we also expect the DOTS profile on fed funds rate increases to reveal the same median for 2017 as in September – that is two rate increases to a median level of 1.13% at the end of next year. Where there are forecast tweaks we do expect them to be upward in terms of real GDP and inflation and downward in terms of the unemployment rate. The basis for changes to forecasts will only be related to economic and financial market developments over the last three months and certainly the data over that period does suggest justification for more optimistic forecasts on the outlook for the economy.”

“Of course a lack of meaningful change to forecasts should not be read as us here agreeing with the Fed’s projections and for some time we have been of the belief that both the inflation and unemployment rate forecasts lacked credibility. With the U3 unemployment rate now at 4.6% and the U6 unemployment rate at 9.3% (only marginally above the pre-crisis average from 1994 of 9.0%), we do not believe there is much if any slack remaining in the labour market. However, this evening is unlikely to be the time for abandoning forecasts that imply limited further removal of slack and uptick in inflationary pressures. That’s more likely to coincide with the FOMC obtaining greater clarity on Trump’s economic policies and hence the March or even the June FOMC meetings are more plausible occasions for that.”

“There are really only two key aspects that will be important in determining near-term direction for the dollar – firstly, the median DOTS profile and whether there is any increase reflecting the improvement in economic conditions over the last three months and secondly, the tone of Fed Chair Yellen in her press conference. For Yellen there will be no getting away from acknowledging that increased fiscal stimulus in 2017 will likely have to coincide with a faster pace of monetary tightening. But no doubt Yellen will be only too willing to remind the markets of the caveats in that link between monetary and fiscal policy.”

“Firstly, financial market conditions are tightening given the surge in US yields. Secondly, and more importantly the appreciation of the dollar, which on a DXY basis hit the strongest since Dec 2002, could serve to dampen both growth and inflation. So we see ways in which Yellen can curtail dollar buying in her press conference and if executed well could prompt some degree of speculative long dollar position liquidation. IMM data shows leveraged long dollar positioning at its largest since January.”