US Dollar Rally Could Falter If Fed Fails to Maintain Hawkish Bias
The US dollar has rallied significantly from its mid-July lows as consistently hawkish commentary by Federal Reserve officials has led traders to speculate over the central bank’s next move. As of Friday’s close, fed fund futures were only pricing in a mild 6.9 percent chance of a 25bp rate increase this coming Tuesday, as the markets are widely expecting the FOMC to leave rates steady at 2.00 percent. While CPI remains uncomfortably high, the US economy is still facing a major slowdown, as evidenced by the collapse of the housing sector and marked deterioration in the labor markets. However, this doesn’t mean that the US dollar can’t gain further. In fact, overnight index swaps are pricing in a whopping 75bps worth of rate hikes over the course of the next year, and if the FOMC’s policy statement focuses on “upside risks to inflation” rather than the economic slowdown and instability in the financial markets, traders will continue to bet on aggressive increases to the fed funds rate over the course of the next year. However this doesn't mean that the US Dollar can't go further. Ultimately, the fate of the dollar this week will depend far more on what the FOMC says, rather than what it does.
Other economic releases this week are likely to disappoint amidst weakening indicators that reflect American consumption habits. On Monday, personal income is forecasted to contract 0.2 percent, while personal spending growth may slow to a 0.5 percent pace. On Tuesday – well before the 14:15 EDT FOMC announcement – ISM non-manufacturing sector is estimated to fall to 48.0 from 48.2, signaling a contraction in business activity for the second consecutive month. This would be particularly dismal news for the US economy, as the non-manufacturing sector accounts for approximately 70 percent of total economic activity in the country and includes retail, services, and finance. Nevertheless, the reaction of the US dollar on the release of these indicators may only look like a blip on the radar, as the FOMC’s policy statement will have the greatest bearing on where the currency goes next.
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08-03-2008, 08:53 PM
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