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FUNDAMENTAL ANALYSIS

New Fed Scenario and Market Impact

New,Fed, Scenario, Market, Impact, Fundamental Analysis, fx trader, forex

USD (NEER) – As unanimously forecast, the Fed hiked rates, raising the fed funds target range from 0.25-0.50% to 0.50-0.75%, although the important development is that it has revised up the number of hikes envisaged next year, from two to three. The dollar appreciated as result.

In the near term it should strengthen further, reflecting the adjustment of market rates/yields to the new Fed scenario. A further appreciation should not be taken for granted subsequently, and a stabilisation is more likely, at high levels in any case. This is because the Fed did not revise upwards the number of rate hikes estimated in 2018 and 2019, left at three per year. Furthermore, there are still no details of the fiscal stimulus plan the new Trump administration effectively intends to implement. Lastly, the effects of excessive stimulus are debatable, and combined with other sources of uncertainty on the Trump’s general approach to policies, should limit the dollar’s upside margin.

In any case, risks remain skewed to the upside, as the Fed may opt for a larger number of hikes should the effects of fiscal stimulus on growth prove stronger than expected.

EUR – On the outcome of the FOMC meeting the euro corrected significantly, dropping below the critical threshold at EUR/USD 1.05 and hitting a low of 1.0468, just short of the March 2015 low of EUR/USD 1.0458.

Therefore, we have revised down our projections for the euro all along the forecasting horizon, to EUR/USD 1.03-1.05-1.07-1.10-1.15 on a 1m-3m-6m-12m-24m horizon.

We expect weakness to be concentrated in the near term (fluctuations within the EUR/USD 1.00-1.05 range), as this is the period in which market rates and US yields will have a larger margin to rise and price in the new Fed scenario. 

On the other hand, we confirm our expectations for a modest and gradual recovery of the euro subsequently, in the second half of next year, assuming the Fed limits its action to the expected number of hikes and dos not do more. The other important factor which should aid a recovery of the single currency is that the ECB’s expansionary cycle will close at the end of 2017, and the market will start to price in the beginning, albeit gradual, of a monetary policy normalisation process in Europe as well.

However, downside risks continue to prevail, mostly in view of the possibility of the Fed hiking rates more than expected, but also due to the uncertainties generated by the political calendar in the euro area (elections are due in Holland, France, and Germany in 2017, and Brexit may prove to be a source of volatility).

JPY – The yen also declined further on the outcome of the FOMC meeting, entering the USD/JPY 117 area (low of 117.86). Therefore, we have revised down our projections for the yen throughout the forecasting period, to USD/JPY 119-120-122-124-125 on a 1m-3m-6m-12m-24m horizon. Unlike the euro, the yen should continue to decline next year, even beyond the near term, on the widening of differentials between US and Japanese yields. This is because the Fed will keep hiking rates, whereas the BoJ will press on with “curve control” for an extended period, until inflation is back to target.

GBP – Sterling corrected as well following, the FOMC, from GBP/USD 1.27 to 1.25, but slightly less than the euro, against which it strengthened somewhat as a result, from EUR/GBP 0.84 to 0.83. Over the next few months, however, the trend of the pound should prove less dependent than the euro’s on the evolution of the picture in the US, and will be more heavily influenced by Brexit process.

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