Not So Dovish Fed Pushes Dollar Higher

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Market Drivers Dec 17, 2015

EUR IFO bit lower across the board
GBP Retail Sales
Nikkei 1.59% Eurostoxx 2.67%
Oil $35/bbl
Gold $1066/oz

Europe and Asia:
EUR IFO 108.7 vs. 109
GBP UK Retail Sales xx vs. 2.3%

North America:
USD Philly Fed 8:30

USD Weekly Jobless 8:30

The was some follow through in dollar strength in Asian and early European session trade today in the wake of the much anticipated rate hike decision by the Fed. The Fed raised rates for the first time since 2006 hiking the benchmark by 25 basis points.

Although Fed Chairwoman warned repeatedly that this credit tightening cycle will be much more gradual than those of the past, she refused to adopt a pure dovish posture and her lack of concern about the recent volatility in the high yield markets was taken as a sign that the Fed sees the US economy to be more resilient than initially thought.

Ms. Yellen’s comments about the financial system were thought to be the tipping point for a dollar rally post FOMC presser and the greenback extended its gains in early European dealing with EUR/USD dropping to a low of 1.0830 while USD/JPY rose to 122.64.

We’ve long argued that having decided that it wants to normalize policy the Fed was unlikely to send a “one and done” message to the markets if for no other reason than to preserve its credibility. Whether US monetary authorities choose to increase rates any further in 2016 remains to be seen, but for now at least dollar bulls have the upper hand as market psychology has clearly shifted towards the buck.

In eco news tonight the IFO report came in slightly lower than expected at 108.7 versus 109 eyed but the news had virtually no impact on trading as euro remained near the 1.0850 level for most of European session. The allure of the 1.0800 stops will no doubt attract dollar bulls in North American session but for now that level appears to decent support as the market will need further confirmation of US economic strength before it starts to price in the prospect of additional tightening by the Fed.

Meanwhile in UK, the Retail Sales data was much better than anticipated with headline reading rising by 3.9% versus 2.3% forecast. The jump in consumer demand was driven by strong Black Friday sales and is yet another indication that the UK economy is perhaps the strongest of all the G-7 nations. Yet despite the positive print cable could not hold the post news rally and sold off below the 1.5000 figure in the aftermath of the release.

It is perhaps the greatest irony of the currency market right now that sterling is so weak on a relative basis especially against the euro given the divergence in economic growth. Yet the BOE remains resolutely dovish despite generally healthy wage and labor growth and pick up in consumer demand. The culprit in our eyes is political rather than economic. As long as the UK-EU negotiations remain tense, the unsettling prospect of Brexit is likely to weigh on the pair and what’s worse hold the BoE back from normalizing policy for these very reasons. Not so long ago the market was bullish cable on the assumption that BoE would follow Fed’s lead. But prospects for any near term UK rate hike remain dim and that dynamic continues to keep a lid on cable for now.

Boris Schlossberg
Managing Director

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