newdigital

1- In the 3 weeks leading up to the last FOMC meeting, the Dollar went parabolic, appreciating almost 5% versus the majors. Dollar strength was especially noticeable for EUR/$. It is well understood that the FOMC does not target the Dollar, merely taking the greenback as an input into its forecasts. But the parabolic rise in the USD into the meeting is certain to have been noticed, not least since the last vestige of forward guidance (the "patient" phrase) was scheduled to be dropped.

2- Going into the March 18 meeting - there was some risk that Dollar strength could run out of control. Perhaps as a result, the meeting took a dovish turn, with the dots and economic forecasts taking a sizeable shift down.

3- There is now a feeling that the Dollar story is over, because any further appreciation will just cause the Fed to shift in an even more dovish direction, delaying 'lift-off' further and further. GS' Jan Hatzius and team expect activity to bounce back sharply this quarter rising from a likely pace of 1.2% quarter-over-quarter in Q1 to 3.5% in Q2. We think this rebound will break the infinite loop the market currently expects and means that, however reluctantly, the Fed will likely do 'lift-off' later this year.

4- We think this means that the Dollar still has lots of room to strengthen, not least with market pricing for front-end interest rates as low as it currently is. We continue to forecast a 20% rise against the majors over the next three years.

5- Where does all this leave us going into tomorrow? The sharp pick-up in Fed speakers who have flagged the Dollar recently leaves little doubt in our minds that the Fed will do as little as possible to encourage Dollar bulls. We expect a purely "factual" statement, with our US economics team flagging small twists to the opening paragraph acknowledging the recent slow-down in payrolls and perhaps a firming in inflation.

6- This means that we see data, not the Fed, as the next key catalyst for the Dollar to resume its march higher, as it becomes clear that weak Q1 activity was once again an aberration. Surprises tomorrow could come in the form of language describing recent data weakness as "temporary", which would be seen as hawkish by the market. Language ruling out June for 'lift-off' would be seen as a dovish surprise.

GS targets EUR/USD at 1.00 in 6-months and USD/JPY at 125 over the same end of period


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