Forex Institutional Research: Goldman Sachs FX Daily
Key quotes from the Goldman Sachs report:
Going up is hard to do
Over the past year, the Fed has repeatedly arrested the Dollar rise and this week’s FOMC, with the shift in rhetoric towards caution over external risks, marked another iteration. We have sympathy for the Fed’s dilemma. After all, BoJ and ECB easing led the Dollar to rise sharply in H2 2014, before US monetary policy normalization could even begin. For the Fed, this is a major headache because – if our expectation for Fed hikes is correct – USD could rise another 15 percent, i.e. underlying appreciation pressure is large. This might be why the Fed is modulating its message, for fear that sounding upbeat could trigger another sharp rise in the Dollar. In this FX Views, we make three points: (i) dovish shifts from the Fed over the past year have only been able to put the Dollar into a holding pattern, they have not reversed the 2014 rise; (ii) data will ultimately force the Fed’s hand, which is why our US economists have stuck with their call for three hikes this year; and (iii) the underlying case for the divergence trade is stronger, not weaker, given that a dovish Fed will spur US out performance versus the Euro zone and Japan. Going up is hard to do, but the Dollar will go up.
There is no doubt that Wednesday’s FOMC was a dovish surprise. But it is important to distinguish between what this week may signal (delayed tightening) and what it does not (a return to easing). This distinction matters because – as we have learned over the past year – delay only arrests Dollar strength, it does not reverse it. In the big picture, our first commandment for 2016 FX still stands, which is that – following the large rise of the Dollar in H2 2014 – the growth and inflation picture looks robust, which means that underlying momentum in the US is stronger than it appears. This is one reason why our US team has stuck to its call for three hikes in 2016 and why we believe data will ultimately force the Fed’s hand. In the interim, there are obviously questions around the Fed’s reaction function. The one thing that stands out to us is that recent Fed statements have become more volatile: dovish in September over global risks, hawkish in October with the signal for imminent lift-off, dovish in January with the suspended risks balance, and dovish again this past week. This argues against taking this latest surprise too seriously. If we are right about data, the Fed could quickly reverse course, in line with our US team’s call.
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