Will Fed Change the Game for the Dollar?

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Market Drivers Mar. 14, 2016

Aussie gives in to weak CNY data
EZ IP is better
Nikkei 1.74% Dax 1.53%
Oil $37/bbl
Gold $1256/oz

Europe and Asia:
EUR IP 2.1% vs. 1.5% eyed

North America:
No Data

The dollar was better bid on the first trading day of the week in generally quiet Asian and early European session with little fresh newsflow to drive dealing so far. With FOMC meeting scheduled for this week, the focus in the currency market is turning to this side of the Atlantic as traders begin to speculate about Fed policy going forward.

Some analysts including those from Goldman Sachs are noting that market may be underpricing the risk of any interest rate increase from the Fed. With PCE climbing to 1.7% and unemployment at 4.9% rate GS research stated that the former “flight path” of rate hikes may be back in play. For now the markets are extremely skeptical with Fed funds futures pricing in only a 4% chance that anything will be done this week and only at 63% chance that we will see rate hike by December of 2016.

This week’s meeting could alter those expectations. While we doubt the Fed may do anything at this meeting US monetary authorities may hint that they will begin to tighten policy once again as early as next month or perhaps at the next scheduled FOMC press conference in June. The key to their decision will be the volatility in the financial markets. If the markets remain relatively calm the Fed may feel emboldened to act by the start of the summer. Beyond June the Fed is very unlikely to take any action as US will enter the Presidential campaign and generally monetary policy officials prefer to stand down during the political season.

If there is a strong suggestion of more rate hikes to come, the sentiment towards the buck could shift markedly. The dollar was badly beaten last week on short covering flows despite the fact that the ECB lower rates and increased its QE commitments. A hint of a rate hike could reverse that move as focus turns back to fundamentals and interest rate differentials.

For now the EUR/USD has found resistance at the 1.1200 level and could bide its time in the 1.1200-1.1000 range until the FOMC presser on Wednesday, but if Ms. Yellen and company sound a more hawkish note the pair could once again tumble below the 1.1000 mark as the week progresses. Meanwhile with no data on the docket today the price action may remain subdued into North American trade with dollar bias continuing as the 1.1100 support looks to be tested.

Boris Schlossberg
Managing Director

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