US Dollar Fundamental Forecast: Bullish
- US Dollar[1] climbed at the end of last week as markets position for the Fed
- QE tapering is around the corner, but what does the rate hike path look like?
- Risks seem tilted to the upside for the Greenback, eyes on longer-term bonds
The US Dollar strengthened towards the end of last week as the yield curve flattened, likely reflecting rising hawkish Federal Reserve monetary policy expectations. This followed a week where US GDP slowed faster than expected in the third quarter. Meanwhile, the Fed’s preferred inflation gauge, core PCE[2], remained well above the central bank’s target.
All eyes now turn to the November FOMC[3] monetary policy announcement due on Wednesday. Following a shift in the central bank’s tone on inflation, the monthly asset purchase tapering is expected to begin. This is anticipated at a pace of US$10 trillion per month, which is expected to be completed by June 2022. How soon will rate hikes follow though?
Since September’s FOMC rate decision, the markets have been increasingly pricing in a more hawkish Fed. Now, Fed Fund Futures reflect that the markets anticipate 2 rate hikes by the end of 2022. Prior to the September policy announcement, not even one rate hike was fully priced in. Earlier in October, Fed Chair Jerome Powell noted that the risks are tilted higher on inflation.
Still, despite the rapid increase in Fed rate hike bets, the US Dollar has struggled against its major peers. There may be 2 key reasons why. The first can be found on the chart below. The average spread between the 10-year Treasury yield and equivalent bonds from developed countries has been narrowing. This means longer-term rates have been rising more quickly outside of the United States.
