"The Fed is a reluctant Dollar bull," explains Goldman Sachs, noting that Yellen inadvertently revealed the FOMC's expectation that coming policy changes will boost the greenback. Broadly speaking the rest of the sell-side has herded along into the strong US Dollar camp with only Unicredit (rate shift may slow recent very strong USD momentum) and Morgan Stanley (suggesting USD corrective activity) backing away from full dollar bull though most suggest adding to dollar longs on any dip as the most crowded trade in the world gets crowded-er.
Goldman Sachs: The Fed Is A Dollar Bull
1. Price action around last week’s FOMC was jarring. The drop in the Dollar in the immediate aftermath of the meeting was greater than during the “no taper” surprise in September 2013 (Exhibit 1) and conviction that the USD can rally from here has taken a beating. We have a different take and continue to see large upside for the Dollar. Our reasoning is simple. On the surface, there is no denying that last week was a dovish shift, no doubt in response to the sharp rise in the Dollar in the run-up to the meeting. But what does that shift really signal? In our minds, it is an implicit admission that the normalization of monetary policy – a return to data dependence and lift-off – will boost the Dollar. Last week’s actions thus inadvertently revealed the Fed’s expectations for the greenback, which are that coming policy changes will likely boost the Dollar. In a sense, last week was reminiscent of the SNB’s decision to de-peg in January. That action implicitly signaled an expectation that the Euro could weaken a lot more, making the peg increasingly unsustainable. That “forecast revision,” made in the run-up to the ECB's QE, has of course been borne out. Like the rest of us, central banks have implicit currency views, though in the case of the Fed we have to infer those from actions rather than words. Last week’s switch from “patient” to “not impatient” signaled that normalization is coming, but a reluctance to do so in June, for fear that Dollar strength will get out of hand. The Fed is a reluctant Dollar bull.
2. Of course, it is quite possible that the pace of Dollar appreciation slows from that seen since Chair Yellen’s Humphrey-Hawkins testimony (Exhibit 2). But that is hardly a heroic statement. The Dollar has seen outsized gains versus the majors recently, which – as discussed in our last FX Views – reflect Dollar positioning that was too pessimistic (it felt to us like the market was expecting a repeat of the kind of weak data we saw a year ago) and rising focus on “patient” coming out of the FOMC statement. It is perfectly normal for the Dollar to consolidate after such a move. Indeed, following large moves, the USD has tended to trade sideways for several weeks at a time. This time is no different most likely, i.e. this is not the end of the bull-run for the Dollar.
3. There is no doubt that the hurdle has risen for labor market data, which Chair Yellen highlighted in giving the FOMC “reasonable confidence.” But it is also important to remember the bigger picture. The bulk of the Dollar rise has been the Euro and Yen weakness, a reflection of regime change at the BoJ and ECB that pushed the 2-year differential sharply in favor of the Dollar (Exhibit 3). This is why, in our minds at least, the Dollar has been resilient to relatively mixed data in recent months. As such, the hurdle for the Dollar is not really all that high after all. There is an additional facet to this. Last week, Chair Yellen talked back the removal of “patient,” downplaying a June lift-off by saying the Fed would “not be impatient.” Forward guidance, in other words, did not quite leave this time around. Its full removal is another Dollar positive catalyst, which we believe should see the 2-year differential converge further towards the forwards, boosting the Dollar (Exhibit 4).
4. We know we may sound like perma-Dollar bulls. We are not. There will be a turning point, but in our minds that will come once we have gone a lot further towards normalization. Markets will inevitably front-run monetary policy normalization, so the turn will likely come before the Fed funds target reverts to its historical average. But is that moment at hand, before the Fed has been able to fully let go of forward guidance, let alone lift-off? We think not.
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And the rest of the sell-side seems to agree... though positioning varies... (via Bloomberg)
Barclays (strategists incl. Dennis Tan)
- Moved estimate for timing of Fed’s first rate hike to Sept. from June following changes to FOMC’s projections; expect target range for federal funds rate to reach 50-75bps in Dec., vs 75-100bps before
- Don’t expect medium-term downward trend in EUR/USD to change after dovish Fed surprise; use rebound as opportunity to establish short positions at a better entry level
- Local data likely to weigh on pair this wk on expectations of slightly firmer U.S. CPI (look for headline reading of +0.3% m/m, core CPI of +0.2% m/m ) and softer euro-area flash PMIs (expect flash composite PMI of 53.5)
- Forecast U.K. March CPI inflation to fall to 0.0% y/y, RPI inflation to drop to 0.8% y/y; may provide some upward pressure to EUR/GBP
- Yuan rebound may be short-lived, sell on rally
BNP Paribas (strategists incl. Vassili Serebriakov)
- The Fed eliminated “patient” but sounded dovish; case for USD appreciation remains intact
- BNP re-enters long USD/JPY at 120.50, targeting 125 with a 118.50 stop
- Recommends buying a 3-mo. EUR/GBP call, financed by a 1-mo. put with expiry before the May 7 U.K. elections, given likelihood of a hung parliament
- All eyes on U.S. and U.K. inflation data in wk ahead
- Goes long EUR/SEK at 9.20, targeting 9.60 with a 9.0550 stop
- SEK appreciation appears to be raising Riksbank concern; with further easing probable, risk-reward favors SEK shorts
BofAML (team incl. Athanasios Vamvakidis)
- Strong USD will lower real GDP growth and inflation, delaying first rate hike to Sept., or even later
- This could slow USD appreciation in short term, but expect mkt to continue taking advantage of any USD dips to buy more
- Increased concern about negative scenarios in Greece, which could trigger further EUR downside
- Recommends buying a 3m EUR/JPY put spread, as a continued fall in EUR/USD could weigh on risk sentiment given its positive correlation with equities
- Remain constructive on peripheral spreads with carry trades expected to get further boost from QE and TLTROs
Credit Suisse (team incl. Ray Farris)
- USD sensitive to weak data surprises in light of last wk’s Fed press conference as they could further support expectations that FOMC will wait for longer before hiking
- Remain fundamentally USD bullish; use consolidation to add longs at better levels, especially vs EUR
- EUR-specific drivers likely to be on the back burner for the time being; remain EUR bearish, think slow-and-steady increase in Greek bond yields could be a harbinger of increased volatility, potential credit risk down the line
- Turned bearish on GBP, on view low inflation and election risk will increasingly weigh on currency
- Expect Japan core CPI ex VAT hike to continue moderating, to 0.1% y/y; bias remains for USD/JPY topside towards CS’s 3-mo. forecast of 125
- Risk is still for a weaker CNY and CNH trajectory with outflows likely to remain high in the coming mos. and CNY trade-weighted index at a record high
Societe Generale (team incl. Olivier Korber)
- Dovish Fed switch could trigger USD profit-taking in coming wks; EUR/USD should ultimately reach parity even as road will be bumpier from here
- Relief rally in EM assets on back of Fed to be short-lived; ready to fade rally, remain tactically bearish on GEM
- In EM FX, still want to sell TRY, while call for steeper curves in a number of local rates markets, especially Poland and Korea
- Sudden end of former Swiss FX policy has severely challenged credibility of potential future SNB actions, including FX interventions; limits scope of CHF weakness
- CHF strength and deflation raise the possibility of a liquidity trap
- Initiate long NOK/SEK spot position; revived monetary-policydivergence should lift pair toward 1.10
Morgan Stanley (team incl. Hans Redeker)
- Removing the word “patient” from FOMC statement has increased Fed’s flexibility to tighten whenever it sees the need to act
- Yield and interest-rate differentials have become less dollar-supportive, suggesting USD corrective activity
- USD exposure reduced, tightened stops on remaining USD long positions
- Trades such as long JPY/KRW and long CLP/COP provide relative value
- Greece and local French elections next weekend are EUR-specific risk events, limiting euro rebounds
- CAD/JPY shorts offer value, with the steep fall of oil prices undermining the CAD outlook
- Further commodity-price weakness isn’t fully priced in
UniCredit (strategists incl. Vasileios Gkionakis)
- FOMC’s downward shift in interest-rate projections may halt recent very strong USD momentum
- Therefore, most important U.S. data – CPI and durable orders - unlikely to re-ignite strength across the board
- Euro-area data have potential to push EUR/USD even higher
- Preliminary March EMU PMI surveys should post fourth consecutive increase for both manufacturing and service
- Together with a stronger German Ifo Business Climate for March, likely to offer EUR/USD more fuel
- Any further deterioration in Japan Feb. inflation will keep the market warm to the possibility of additional stimulus
- High level of uncertainty around general election, dovish BOE likely to weigh on the GBP; CPI release might add some pressure
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And then Stan Fischer explained...
- *FISCHER SAYS DOLLAR WON'T KEEP RISING FOREVER.
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Reflecting on today's significant weakness in the Dollar, the Goldman traders noted...
USD weakness continues today but unlike last week the move today was on much lighter flows.
We were net better sellers of USD across the board but I think some of that is position reduction given the high level of realized vol we’ve seen. EURUSD has had at least a 125bp move day/day the last 4 sessions. Will be interesting to see if the USD rally can reignite once things calm down because recent FED speak continues to emphasize that a rate hike could come mid-year.
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