Since the beginning of July, the US Dollar has entered into a bull momentum and nothing seems to stop its trend. The USD index surged by almost 9% in the past three months and is now trading at a four year high at 85.65 (June 2010 levels to be precise). With the Fed about to finish tapering at the next meeting in October ($15bn cut) and policymakers acting much more confident (compare to H1) due to stronger macro indicators and an equity market still ‘rallying’, the market didn’t hesitate to position itself back into US Dollars.
If we have a look at the last Fed’s dot plot below, Fed Officials raised their median estimate for the FF rates at the end of 2015 to 1.375% (vs 1.125% in June). Moreover, by the end of 2017, the majority of the committee expects the FF rate to rise to 3.75%.
(Source: Federal Reserve)
With the unemployment rate sitting at 6.1% (below the once-used-to-be 6.5% threshold), growth revised higher in Q2 at annualized 4.6% (vs. 4.2% in previous estimate) and most of the fundamentals being stronger (except August NFP and dismal durable goods that came in at -18.2% MoM), the market is looking at an earlier-than-expected rate hike in the US. We heard and read Q2 seems likely. In our opinion, US policymakers are making a mistake as they should have let the market ‘swallow’ a period without QE before starting to be more explicit concerning their ST monetary policy (see article Could we survive without QE?). We agree the Fed’s recent ‘move’ has probably made the joy of most of the central banks as all the currencies have been trending lower against the US Dollar. However, it looks to me that the recent talks we’ve heard have been premature [a bit] and in case of disappointing fundamentals, the Fed could easily switch to another mute period (aka BoE lately).
Based on our latest discussion with the strategy team, we agreed there are several factors that could continue to hold back a significant growth acceleration in the near term. For instance, mortgage applications (MBA Purchase Index: orange line) in the US stands at a 14-year low even though the 30-year fixed mortgage rate (black line) is still trading at ‘decent’ low levels (4.39%, vs. an average of 6% between 2002 and 2008) as credit conditions are much tighter now.
Moreover, wage growth continues to increase only at a modest pace (except for skilled workers in areas such as health care) and will continue to weigh on personal consumption expenditures, which represents roughly 70% of the US economy.
US data this week:
– Important figure to watch this week will be September Non-Farm Payrolls on Friday, which is supposed to print above the 200K (215K according to pools).
– September Average Earnings and Workweek Hours (Friday) are expected to print at 0.2% MoM and 34.5h.
– ISM Manufacturing PMI should remain strong at 58.5 on Wednesday.
Chart on STIRs: As we mentioned it in some of our previous research, the implied rates on the FF December 2015 and December 2016 futures contracts suggest that the Fed’s target rate will the end the year at 75bps in 2015 and 112bps in 2016 respectively.