The US Dollar is vulnerable to a sharp upside repricing if the Fed hikes rates at the March FOMC. Although the market has already swiftly repriced the likelihood of a March hike following the recent Fed comments, the pricing for the cumulative increase in rates over the next two years has only changed slightly. A hike in March could pave the way for two more hikes over 2017 if data remains consistent over the year.
Fed releases chart examples to illustrate uncertainty around policymakers’ macroeconomic & interest rate projections https://t.co/s039fGBBnk
— Federal Reserve (@federalreserve) March 3, 2017
Considering the current environment in terms of tactical positioning and political risk, GBP looks like the best vehicle for expressing a long USD bias. Macro and monetary policy both suggest a lower GBPUSD rate with political uncertainty linked to Brexit exerting downside pressure. The triggering of Article 50 is going to happen at some point over the next few weeks, and exit negotiations are likely to be tough for the UK as EU leaders are unlikely to make an easy path for the UK to leave the union. Furthermore, recent data has started to show weakness in the post-referendum landscape with PMI data sets heading lower while wage growth has stalled well below the BOE’s inflation target. The squaring of short positions over recent weeks also creates plenty of scope for downside momentum on an upward repricing of US rates.
Price is still moving within a clear bearish channel formed on the post- flash crash correction. Having broken through the rising trend line from year to date lows, the focus is now on the downside with the January low of 1.1984.
For EUR an uptick in activity as well as an improved inflation outlook are providing support while political risk linked to the upcoming Eurozone elections are exerting downside pressure. Given the uncertainty around the election, it Is difficult to gauge direction in EURUSD. On one hand, there is the potential for severe re-denomination risk to accrue in EUR and EUR-denominated assets if Le Pen wins the French election, although this is the outsider scenario.
In this situation, EUR would likely accelerate below parity. However, there is also the potential for a sharp move back into the 1.10 – 1.20 zone if Macron wins the election (as expected) and discussions build around the ceding of some French sovereignty to Brussels regarding better fiscal integration. This occurring at a time where GDP is moving notably above trend would be enough to fuel a rally In EUR and EUR assets.
For now, EURUSD is resting on key structural support at the 2015 lows, trading in the middle of a clear bearish channel that has formed over the last 15 months.
Considering the relevant monetary policy and macro factors, JPY stands to be the biggest loser on a US rate hike in March. Core inflation continues to run significantly below the BOJ’s forecast. The BOJ has also reaffirmed its commitment to running an inflation overshoot which means rates will stay at current levels for longer.
Price remains trapped between resistance at the 115.55 level and support at the 111.83 level with a local bearish trend line capping the upside also.
On the back of hawkish comments by various Fed members last week, market pricing of a March hike has jumped from around 30% at the start of last week to over 80% now. However, the cumulative number of rate hikes priced in over the next two years has only marginally changed. This creates scope for plenty of upward movement in USD as the market reprices the Fed rate path over the forecast period.
At the same time, the ECB, BOJ, and BOE are likely to remain on hold due to the large divergence between the inflation outlook and the forecast for the output gap. Consequently, USD has plenty of room to appreciate against EUR, JPY, and GBP.