USD surge on pending rate hikeBy Arnaud Masset
Demand for US dollars rose on Wednesday, as investors await the outcome of the today’s policy meeting of the US Federal Reserve. There is no question the Fed will raise short-term interest rates by 0.25%, which will bring the target to 1.75-2%, but investors remain cautious amid uncertainties about future policy. We expect a signal of one more rate hike this year, most likely in September, as well as a moderate upward adjustment in the growth forecast. Also the Fed will consider a slower tightening, as the effect of balance sheet unwinding kicks in.
According to official data, the US economy is solid, with inflation rising towards the Fed’s 2% goal. Still, Fed officials won’t get ahead of themselves and will act cautiously. The Fed started to unwind its $4.5 trillion balance sheet just months ago: it will take a few more months to see its effects on reducing dollar liquidity. Also, the impressive gains in jobs have not translated into increased real wages. Despite improvement in nominal wages, increased inflation has eroded wage gains. Inflation-adjusted wage growth eased for a second straight month in May as it rose only 0.3% annually compared to 0.4% in April.
Short the yenBy Peter Rosenstreich
USD/JPY and EUR/JPY should be reloaded now This week’s Bank of Japan policy decision will be to hold rates. USD/JPY continued to strengthen ahead of critical US Federal Reserve and BoJ meetings. The BoJ has made it clear: no change should be expected. In addition, the trade dispute with the US has caused some distortion in the market pricing of the Euro. Monetary policy divergence remains the primary drive in USD/JPY positioning.
Inflation is far off target, and the BoJ has said that changes would materialize only when inflation reaches the bank’s target. Growth has also disappointed, led by weakening private demand, indicating a target-hit is also unlikely next year. Investment and consumptions could easily correct lower should, weighing on wages and prices, should the market feel that the stimulus is now causing stocks to fall. Therefore, further easing could be on the table to prop-up asset prices and confidence. Finally, the political threat to Prime Minister Abe and ‘Abenomics’ has faded. With a firm grip on power, Abenomics could fire up again.