Shortly after the Fed adopted the so-called “clean relent”, in September, we explained the dollar dilemma Janet Yellen faces in hiking rates. The problem for the Fed - and this is well worn territory by now - is that even as 25 bps might fairly be characterized as merely “symbolic”, it still marks a notable policy divergence from the rest of the DM world which is still in easing mode.
That means a hike risks making an already strong dollar even stronger which, depending on the gravity of the move, could have far reaching consequences on everyone from China, to EM as a whole, to US corporates (who aren’t keen on losing competitiveness).
In the simplest possible terms (via Goldman): “The Fed is struggling with a basic dilemma: how to normalize US monetary policy without the Dollar going through the roof.” Here’s a look at the trajectory the Fed is attempting to negotiate (the right pane separates EM FX from the majors for context):
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“One of our core views is that the normalization of US monetary policy will result in a substantially stronger Dollar and we forecast the greenback to rise 14 percent through 2017,” Goldman said, in a note out this morning. “The Fed is worried about this scenario, to say the least, which might be one reason why Chair Yellen has begun to sound like an FX strategist in her press conferences.”
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So, as we wait to see how many times FX strategist Yellen mentions the dollar and/or import prices on Wednesday, it’s worth noting that when it comes to crowded trades, the dollar takes the proverbial cake according to BofAML’s most recent fund manager survey.
Fully 53% of respondents said the dollar was the most crowded trade (short commodities was a distant second at 16%). That’s up sharply from just over 30% last month.
Meanwhile, when it comes to positioning, FMs are amusingly all-in on the very same trade they themselves say is three times as crowded as the next most overcrowded position:
Finally, here's a look at which factors FMs think might play a role in brining about an end to the USD bull market:
So there you have it: "Fed hiking cycle ends" is the most likely catalyst for a reversal of fortunes for the surging USD according to money managers.
Of course if liftoff swiftly triggers an EM meltdown characterized by rapidly accelerating capital outflows and the inexorable depletion of reserves to shore up flagging EM FX then we suppose the USD bull market will be over in relatively short order because if 25 bps tips the world into chaos, we'll be back to ZIRP by the end of March.