Fed’s pre-set course is a bore for the $ but music to the ears of EM FX - ING

Viraj Patel, Research Analyst at ING, sees Fed policy as a negligible factor for the USD in 2018 – and the latest set of FOMC minutes did not disappoint here.

Key Quotes

“The binary nature of views within the committee on big picture economic issues like the equilibrium unemployment rate, the factors behind currently low US inflation and the level of the neutral interest rate, suggests to us that the Fed will continue to muddle through 2018 on their planned pre-set course. With markets already pricing in 60bps (i.e., more than 2 hikes) worth of Fed tightening for 2018, we think US monetary policy will provide little upside to the USD over the coming year.”

“Indeed, FX markets thrive on unpredictability and mispricings – and therefore monetary policy as a driver for currencies packs more punch in economies where the gap between actual policy rates and neutral interest rates is the biggest. For the US, if one were to view terminal rates to be around 2.0-2.5% – markets are pretty much pricing this in. Debating over a few hikes here or there won't set a new trend for the $.”

“US monetary policy can only be a factor for the USD in 2018 if we see a major regime shift – or something that causes a split Fed moving cohesively towards either the dovish or hawkish spectrum:

• On the hawkish side, the tail risk is that we see the appointment of strong hawks to the 4 open Fed Governor positions. Even though hypothetically this may create a bit of short-term noise in markets, we think the hard economic data will ultimately prevail the economic ideologies of new policymakers.

• On the dovish side, the tail risk is if the Fed were to take its symmetric inflation mandate more strictly and embraces the idea that constant missing of its 2% target requires a more gradual policy approach than currently signalled. This was indeed flagged in the FOMC minutes – with some members stating that the Fed should consider studying alternative frameworks such as price-level targeting.”

“Neither tail risk seems likely under a Powell-led Fed – where continuity seems to be the most likely path forward. Yet, while the predictability of Fed policy will be a bore for the USD – it will be music to the ears for risky assets. Certainly, our view for a benign global risk environment – and a conducive backdrop for EM FX – is based on the assumption of a risk-averse, pre-set Fed. The bottom line is that US monetary policy won’t be the catalyst for a downturn in global markets in 2018.”