Ashraf Laidi

Market Analyst

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6 Reasons for the Dollar Decline

By Ashraf Laidi  |  14/12/2017 12:44
dollar and euro fx analysis

As Fed Chair Yellen delivered her 5th and final rate hike, the combination of the FOMC forecasts (dot plot) and Yellen’s press conference failed to issue any hawkish signals anticipated by most market participants. As a result, the US dollar fell across the board, gold rebounded from its $1240 low as anticipated in my video and piece, while US 10-year bond yields failed yet again to break above 2.40%. And if you watched my video on gold seasonality, the dynamics remain in track.

We delve deeper into the main reasons behind the dollar slump.

1) Dots showed 3 not 4 hikes – The reason to the US dollar’s immediate decline following the Fed announcement is the revelation that the FOMC dot plot and median projections continued to show three rate hikes for 2018, rather than the four anticipated by some US dollar bulls.

2) Inflation not high enough. Yesterday’s release of the October CPI report showed core inflation at 1.7% y/y compared to 1.8% expected. That sent the dollar 30 pips lower and set the tone for the day. More importantly, the Fed’s preferred inflation target – core PCE price index is at 1.4%, well below the 2.0% objective.

3) Tax reform – It’s a remote possibility, but there is a small chance that the US tax bill falls apart (or is diluted) in what would be a major hit to the stock market and to Trump’s agenda, along with USD. Some Senators are holding out support and the Alabama Senate election puts a tighter timeline on the bill.

4) Fed’s inflation outlook – The Fed’s dot plot bumped up growth and employment forecasts but kept its median inflation projections unchanged.

5) General caution – Neither the statement, nor Yellen’s press conference exhibited the kind of enthusiasm shown for higher US growth by the markets for next year or by the global synchronized expansion. The consensus at the Fed was that the tax plan won’t add much so that’s another thing that will leave them more inclined to wait. In fact, Yellen reiterated that the economic effects of tax reform remained “uncertain”.

6) March expectations were high – the dollar had a tough bar to overcome. The Treasury market was pricing 63% chance for March 2018, which subjected the currency to downside risks from any slight disappointment.

Onto the BoE
Will USD weakness remain after today’s announcements from the European Central Bank and the Bank of England? I see little change. The Bank of England will likely unanimously vote for keeping rates unchanged. Governor Carney would has no choice but to firm up the value of the pound in order to cap inflation via currency policy rather than monetary policy. Since the economy cannot handle another rate hike so soon, it requires steady currency.

And the ECB

In the case of the ECB, today’s announcement follows the October decision to begin curtailing the size of QE to €30 bn-a-month from €60 bn-a-month starting from January into September 2018. Any potential upside surprise today in upward revisions to GDP growth will likely be offset by keeping CPI forecasts unchanged. Traders will also look out for reporters’ questions about the extent of dissent in October’s decision to halve QE size and extend its duration, but Draghi will likely to maintain the same answer of indicating there was dissent but not by how many members.

Considering the rise in energy prices, I see room for a slight nudge in inflation forecasts, in which case may boost the euro. Although Draghi is known for his rhetorical manoeuvres to manage the currency, I see the path of least resistance for EURUSD to chart towards $1.23 mid next Q1.

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