USD gains will be limited – HSBC

Research Team at HSBC, suggests that we need to re-think how we view the link between the Fed and the USD as we are not witnessing a traditional tightening or normalisation.

Key Quotes

“This has turned out to be a different type of tightening, what we have dubbed an abnormalisation. There is no pre-determined idea of where rates may end up and hence forward guidance based on Taylor rules or output gaps has been thrown out the window. This has become a fluid, data-determined process where the USD will play a central role in determining the pace and extent of interest rate hikes. The USD in no longer a consequence of normalisation process but has become an integral part of the abnormalisation process.

The Fed has also identified that the USD has been a key reason why inflation has undershot its target for the last few years. Policymakers will not want to foster additional headwinds to the reflation effort. In addition, while a stronger USD can be compared to a rate hike in terms of its effects on the US economy, they are not identical as a rate hike that leaves room in the future for conventional easing if required. Finally, given the Fed and the market are agonising over whether they will move once, twice or three times this year, even a small move in the USD can have a material impact on the rate debate.

Abnormalisation creates a feedback loop for the USD. Currency weakness would open the door to a hike and provoke USD buying but that, in turn, would potentially rule out the hike leading to USD weakness. The circularity suggests the USD is unlikely to see a lasting trend based solely on Fed policy.”