Dollar rallies as FOMC turns hawkish
24/Mar/2014 • Currency Updates•
In an otherwise quiet week, currency investors focused mostly on the Federal Reserve meeting on Wednesday. They were not disappointed, as the FOMC statement, its projections, and Chairman Yellen’s first press conference, all pointed in a hawkish direction. The dollar rallied sharply, rising nearly 1% against both sterling and the euro within a few minutes. The rally continued on Thursday, before pulling back slightly towards the end of the week. With the FOMC and, to a lesser extent, the Bank of England in a tightening modem, while the ECB ponders whether or not to ease policy further in response to deflationary pressures, we think the stage is now set for steady euro depreciation against sterling and the dollar.
The biggest news of the week in the UK, the release of the Government’s budget, turned out to have essentially zero market impact. The OBR revised upwards its 2014 growth projection, to 2.7% from 2.4%. However, the overall fiscal drag from further tightening of fiscal policy will be on the order of 0.7%, more or less as expected, and does not threaten the 2-3% range most economists (ourselves included) expect for 2014. Significant personnel shuffle in the Bank of England was the other news of the week. However, the changes had no clear impact in the relative hawkishness of the MPC overall. Hence, sterling traded all week in line with the euro, reacting to FOMC hawkishness and ending down nearly 1% against the greenback and almost unchanged against the common currency.
As in the UK, the week’s main news came from policy-makers and turned out to have very little market impact. An agreement was finally reached on the Single Resolution Mechanism, the procedure by which the decision of when and how to declare a financial institution insolvent, will be gradually taken away from the individual countries and carried out at the European level. The Germans ensured that the speed at which this process will take place, the amount of money that will be available to it, and the speed of the decision –making, were all disappointingly timid, but this had been expected and the euro did not react. Absent economic news of note, the euro responded badly to the FOMC hawkishness. All eyes now turn to the release of the PMI indicators next week. Some early German confidence indicators appear to have taken a turn down, perhaps on the back of the Ukraine crisis. A pull-back from recent modestly high levels could accelerate the drop in the euro.
The biggest news of the week was of course the surprisingly hawkish outcome of the FOMC meeting. In particular, for the first time since the beginning of the crisis, the projections of the individual members for the timing of future rate hikes were brought forward rather than pushed back. The median FOMC member now expects the rate to be at 1% (i.e., 0.75% higher than today) by the end of 2015, and 2.25% by the end of 2016. Both of these levels are higher than they were back in December, the last time the FOMC published its projections. Further, Chairman Yellen suggested that hikes could begin as soon as six months after the “taper” is concluded, much sooner than most strategists had assumed.
As for macroeconomic news, we remain focused on high-frequency data in the US. This should provide the earliest read on the extent to which the weakness seen in the first two months of 2014 can be attributed to weather effects rather than a cyclical slowdown. Last week’s news was moderately positive. Jobless claims, the most informative weekly data point among US indicators, improved last week and brought the 4-week Moving Average to a new cycle low. This suggests that our view, that the slowdown is mostly weather related, is correct although we will not have all the evidence in place until mid-April at the earliest.