What’s Going On With the USD?
What’s Going On With the USD?
The Fed meets next week
Expectations are for the Fed to hike by 50bps and then to signal another 50 bps hike. Jerome Powell has said that the neutral rates (at 2.4%) are the right level for rates by year-end. So, the Fed has some way to go from the current level of interest rates at 0.85%. The extent to which they deviate from this expected narrative is going to influence the USD.
What to watch
If the Fed surprises with a 75 bps hike or signals a firm move above 2.4% this year then that will once again be USD positive, US10Y yield positive, and a headwind for both gold and equities.
However, if the Fed hike by 50bps and start to show worries over slowing US growth then markets will begin to sense a pause in rate hike from the Fed. That will result in USD weakness, US10Y falls, and gold upside. One potential opportunity to watch for would be if the Fed is more dovish than expected as that should sink yields, sink the dollar, and lift gold. See here for an explanation.
The global picture
The other key factor to watch for the USD is due to it being used as a global currency. When the global economy is growing then the USD depreciates. When the global economy is slowing then the USD tends to appreciate. Take a look at this helpful USD smile theory graphic to get a handle on the different drivers for the USD.
Positioning
Markets have been buying the USD for some time now on expectations of an aggressive Fed. The market is now vulnerable to a correction lower if we see evidence that the Fed will need to be less aggressive in hiking rates. The USD is around one standard deviation higher from the mean, so there is less incentive to chase the USD higher from here.
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