US Dollar Risks And The Four Fed Surprises

Tyler Durden's picture

The Federal Reserve holds its last policy meeting of 2013 in the week ahead. In UBS' view there are four possible surprises that could affect the markets. From the odds of a taper to adjusting forecasts and from forward-guidance communication to the chances of a cut in the IOER, the FOMC meeting in the week ahead presents upside and downside risks to the dollar in the near term; even if UBS believes the longer-term will see USD strength against both the EUR and JPY.

Via Syed Mansoor Mohi-uddin of UBS,

First, the Federal Open Market Committee may decide to start tapering its $85bn a month of asset purchases. UBS Economics expects policymakers will wait until the January 28-29 FOMC meeting as inflation remains well below the Fed's 2% target. Until recently the strong consensus view was for the Fed to wait until its March 18-19 meeting. But the prospects for policymakers to move earlier are rising.

At the September 17-18 FOMC meeting officials refrained from tapering, citing weakening economic data, upcoming fiscal risks as the government prepared to shut down in October, and tightening financial conditions. Three months later those hurdles are substantially lower.

US data continues to firm. Payrolls have increased by 204k jobs on average per month over the last four months. November ISM printed at 57.3 its highest level since the spring of 2011. November's retail sales increased by 0.7%m/m. In addition, September and October's retail sales were revised higher to 0.1%m/m and 0.6%m/m respectively.

Furthermore, the risk of another government shutdown has receded. Last week the House of Representatives voted for the budget deal agreed between Republican Ryan and Democrat Murray. This is the first bipartisan budget to pass the House in four years. It will only marginally reduce planned spending cuts, and still needs to be passed by the Senate. But more significantly it markedly improves the outlook by reducing fiscal uncertainty for the next two years.

Financial market conditions also appear more benign in the run up to this month's FOMC meeting. In particular ten year bond yields remain below 3.00%. In contrast, before September's FOMC meeting, Treasury rates had almost doubled from 1.60% in May to 3.00% in September.

Before the Fed's latest 'black-out' period began, three FOMC members spoke. Richmond Fed President Lacker said he expected tapering to be discussed at this month's meeting. Dallas Fed President Fisher said the central bank should begin cutting its bond buying at the 'earliest opportunity'. Both hawks are non-voting members of the FOMC this year, though Fisher will get to vote during 2014. In contrast, St Louis Fed President Bullard, a voting FOMC member in 2013, said tapering should remain depend nt on upcoming data especially as inflation remains well below the Fed's 2% target. But Bullard also said 'a small taper might recognize labour market improvement while still providing the [FOMC] the opportunity to carefully monitor inflation during the first half of 2014.'

If the Fed does announce in the week ahead that it will start tapering its asset purchases - and makes no other policy changes - we expect the dollar will benefit. The FOMC holds eight meetings a year. If tapering is agreed this month, the Fed could potentially finish printing money well before the end of 2014. In his November 20 speech to the Economists Club in Washington DC, Chairman Bernanke made it clear policymakers are more comfortable exercising control over the Fed funds target interest rate than through 'Large-Scale Asset Purchases'.

Second, the FOMC will release updated economic forecasts at its upcoming meeting. Every March, June, September and December, each FOMC participant produces new 'Economic Projections' for GDP growth, unemployment and the Fed's preferred measure of inflation, changes in Personal Consumption Expenditure prices. At the September FOMC meeting, the 'central tendency' forecasts that exclude the three highest and three lowest estimates showed policymakers projecting GDP growth to rise from 2.0-2.3% in 2013 to 2.9-3.1% in 2014 and 3.0-3.5% in 2015. The strong pickup in activity in the next two years is partly based on this year's sharp 'sequestration' spending cuts not being repeated. At the June FOMC meeting, however, officials were even more optimistic on growth in 2014, expecting the economy to expand by 3.0-3.5% next year. If policymakers decide to revise up their projections for GDP growth in 2014 at this month's FOMC meeting - following stronger US releases during Q4'13 - it would suggest officials may be willing to cut asset purchases at a faster pace next year and thus end the Fed's current round of quantitative easing earlier.

The speed of tapering will also depend on how the Fed sees unemployment and inflation. At the September FOMC meeting, policymakers' central tendency forecasts for America's jobless rate was 7.1-7.3% at the end of 2013, 6.4-6.8% in 2014, 5.9-6.2% in 2015, 5.4-5.9% in 2016 and 5.2-5.8% in the 'longer run'. November's jobs report shows the unemployment rate has already fallen faster than anticipated to 7.0%. The FOMC may revise its forecasts lower for unemployment as a result.

Stronger GDP and lower unemployment projections would - by itself - support the dollar. But FOMC officials may also show more concern about the low levels of inflation in the US economy. The Fed targets core PCE inflation to reach 2%. At the September FOMC meeting, the central tendency forecasts here were 1.2-1.3% by the end of 2013, 1.5-1.7% in 2014, 1.7-2.0% in 2015 and 1.9-2.0% in 2016. In October, however, core PCE inflation only rose 1.1%y/y. FOMC participants may downgrade their near term forecasts as a result. That may temper the Fed's willingness to slow down asset purchases.

Third, the FOMC may decide to lengthen its forward guidance on future rate hikes. That may weaken the dollar. Currently, the Fed has committed to keeping the Fed funds target rate unchanged near zero unless the FOMC forecasts core PCE inflation will breach its 2.0% target and hit 2.5%y/y or if unemployment falls to 'at least' 6.5%. FOMC members are not projecting core PCE inflation to reach 2.0% until 2015 at the earliest. But unemployment on current trends may hit 6.5% in the next few months.

Fed doves including Bernanke, Vice Chair Yellen and New York Fed President Dudley are worried that the jobless rate is falling faster than expected because participation rates have fallen to 35 year lows. Thus, the unemployment rate is over-stating the health of the labour market and does not warrant the Fed to start raising interest rates in the near term. In his November 20 speech, Bernanke said the central bank could agree to keep interest rates unchanged even if the jobless rate fell well below the Fed's current 6.5% threshold. Nevertheless, if FOMC officials want to make it clearer that the Fed funds target rate will not be raised for some time after the central bank finishes quantitative easing in 2014, policymakers may decide to lower the 6.5% unemployment threshold for future rate hikes.

If the FOMC agrees to reduce the threshold to 6.0% then it would signal the Fed is likely to still start raising interest rates before the end of 2015. That's because the FOMC currently forecasts the US jobless rate will be 5.9-6.2% by the end of that year. A move from 6.5% to 6.0% would largely be in line with futures markets expecting the first Fed hikes in late 2015. The impact on the dollar would thus be modest. But if the FOMC was to cut the threshold from 6.5% to 5.5% then the impact on the dollar would be more adverse. Currently, the FOMC projects unemployment will be 5.4-5.9% at the end of 2016. Thus the Fed would be signaling that it could potentially see interest rates on hold for another three years.

Fourth, the Fed may surprise by deciding to cut interest on excess reserves (IOER) if FOMC members want to signal more clearly the Fed funds target rate will not be quickly raised once tapering starts. Currently, commercial banks hold around $2.5trn of excess reserves at the Fed and the central bank pays 0.25% interest. The October 29-30 FOMC meeting minutes said 'most participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage'. Former Fed Vice Chair Blinder argued in a Wall Street Journal Article that the inclusion in the FOMC meeting minutes was significant as participants had generally been opposed to such a move. If the Fed does go ahead and cut its IOER rate to zero, the dollar would likely weaken at the surprise decision.

In short, the FOMC meeting in the week ahead presents upside and downside risks to the dollar in the near term. In the longer-term, however, the greenback's direction is likely to be clearer as the strengthening US economy induces the Fed to reduce its asset purchases and enable the dollar to rise to 1.25 against the euro and 110 against the yen as quantitative easing finishes next year.

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ToNYC's picture

UBS believes USD > EUR and JPY. I believe  I'll have another drink and we're both right. Save right here.

Boris Alatovkrap's picture

You are must be drunk to believe in $USD, or US Government Treasury, or US Government. Same is Russia, but that is why Vodka is #1 popular libation in Russia.

All Risk No Reward's picture

Boris, I'm reading Gulag Archapeligo...  where Solzhenitsyn blames the pathetic, cowardly apathy of the commoon Russian galactic chump for the hell on Earth reigned down by the Russian establishment.

Here we go again.

I believe in the US dollar - but, then again, I know what it is.

I believe it is a covert prima facia fraud engineered to systematically asset the real resources from the Chumptocracy that thinks it is a Democracy when it should be a Democratic Republic.

It is a Trojan Horse mechanism engineered to destory American sovereignty and create the Rise of the uzBanksterstan.  It is the physical manifestation of the Debt Star - a financial neutron bomb designed by the Predator Class to seize almost all the assets of the Ilmonetarate Class.



So, yeah, all this pretending the dollar isn't chit are the ravings of people who wouldn't recognize THE PHYSICAL MANIFESTATION OF THE MOST EFFICIENT MILITARY WEAPON EVER DEVISED AND CREATED BY MANKIND.

Debt based money kills more people every month than nuclear bombs have every killed.

We really need to elevate our perceptions and understandings of what is really in play here.

This take down is so efficient it could be supernatural in nature...  yet the ignorati attributes it to ignorance on the part of the Predator Class that is destroying the Prey Classes future WHILE BUILDING CASTLES FOR THEMSELVES...



Exponere Mendaces's picture

There's no way they can even begin "tapering". They'll jawbone about it a lot though, trying to juice the markets for sheer effect. When they finally run out of ammo, we'll get a nice distracting war to carry us the rest of the way to crazytown.


All Risk No Reward's picture

Destroying the economy and buying it up for pennies on the dollar with money they looted from you is all part of the plan.

That phase will commence when the looting phase has been deemed to have run its course.

Ben doesn't give a chit about you or the general public, but he sure wants to avoid the CIA hit team that would take him out if he didn't follow uzBanksterstan Oligarch orders.

Matt1973's picture

Soon, tapering will be seen as a positive

Boris Alatovkrap's picture

Boris is notice poop is always taper... never is similar uniform diameter, but is always very narrow upon exit. This is so buttock is not slam.

Midas's picture

Boris is must eat beet beyond normal consumption.  Increase of potato soda and decrease of cabbage will reduce taper.

Boris Alatovkrap's picture

Dollar & Risk = redundant is no?

ZH Snob's picture

the only question is if the fed has given the high sign to the insiders to short the market.  then we see responsible tapering followed by a huge crash.

yogibear's picture

An uncontrolled dumping of the US dollar would be shocking for the Fed. They like to control everything.

There are plenty of fault lines in derivatives.

A financial nuke in the derivatives could start the process going.

surf0766's picture

The Fed can never tapper.

mumcard's picture


mumcard's picture

They'd better make that announcement from the plane leaving to Geneva.

optimator's picture

Inflation will always remain well below the Fed's 2% target, so they will never taper. (Catch 22)

kito's picture

I can't wait to see everybody's face on here (figuratively speaking of course) when Ben tapers in the next few months and stocks continue to fly and the 10yr goes to 3.15 and nothing else happens. It's going to be fun. That will be the zh surprise.

Hedgetard55's picture

How will "stocks fly" when there is no new money being thrown at them dude? Stocks will tank if Ben tapers.

mumcard's picture

Real estate is coming back too, those millions of empty houses being hidden off the market are going to suddenly turn into unicorns.

kito's picture

Stocks will fly because bens tapering is the "all clear" for the economy. And the world still worships Ben and they will fall to their knees and give thanks to him for the rising and setting Sun, for food on their table, for being the Almighty. And you are a fool to think otherwise.

centerline's picture

Nah.  It's timing... misdirection.  Like a card trick.  Game theory at it's best.  It is all the Fed really has.  The only power it has is what we supply.  The real beef is right here in the real world.  Governments going nuts and chasing capital.

EU is screwed.  No common debt.  Japan is attempting to commit suicide via artificial black hole of finance.  China is playing the same games as everyone else (surprise, surprise).  And Russia is beginning to scare the shit out of everyone - again.  What a mess.

Escapeclaws's picture

Nice synopsis. You seem to agree with Martin Armstrong. Are you a disciple of Armstong?

Meanwwhile, what happenred to Gordon Gecko? You would think he'd be plugging gold, now that it's cheap.

wisehiney's picture

T-Bonds sells to the equity pain point, precious already sold to the mine closing point, commodities prices/producer profits down, what sells next? 

(bitcoin selling now)

BringOnTheAsteroid's picture

Mmmm, I think you're way off with this call. Who worships Ben. His tribe members, congress, the talking head media and the oligarchs. I'm pretty sure the rest of us think he's a fucking idiot.

deKevelioc's picture

You took a fine time to start popping pills.

kralizec's picture

There is a certain logic twisted though it might be that makes sense from a completely insane point of view...given the Fed and its minions are stark raving mad...I cannot discount your prediction out of hand.

Such are our times.

But as we all know, the cost of maintaining ever higher levels of insanity is nearing a breaking point.  I predict we will all witness the Great Unravelling together.

centerline's picture

Maybe.  The key is international capital flows.  Everyone is playing the closed system bullshit - talking thier book or their emotions - just like this article.

Reality is that the world is fucked and the last big, fat, open casino is the US markets.  Pension funds dont have a choice.  Big money fleeing anywhere it is being cornered is going to shift somewhere.  Where else is it going to go?  Bonds?  No (lol).  Equities?  Yes.  At least that is my take.

Is the most evil possible outcome too.  Wall Street wins again (along with London).  US Gov gets all the bullshit statistics to call it a strengthening recovery despite the middle class getting poorer and poorer.  The game goes on.  When the flow reverses though... that is when it gets really interesting.  We are a couple of years at least from that.


Escapeclaws's picture

When are they going to go after our pensions, speaking of big fat piles of easy to steal money?

BullyBearish's picture

If there is any way, honestly or dishonestly for the FED to have its cake and eat it too: eliminate QE and have stocks continue to rise while keeping interest rates "relatively low", they will do it. 

badger10's picture

Well its the first time I have seen a bull market with national debt still escalting. Plus a jobless recovery along with slow growth. What possibly could go wrong?

Colonel Klink's picture

Here Mr. article writer try this analogy.  The patient has been on life support for the past 5 years and can't breathe on its own.  What happens when you remove the ventilator.


kralizec's picture

Maybe they'll steal another ventilator and keep the patient limping along a bit longer.

Eventually they'll run out of shit to steal...then the patient will expire for good.

kralizec's picture

Swap out "Illuminati" for "Mafia" and it's a keeper!