The narrative on the dollar is turning again and the upcoming Federal rate hike will signal the last phase of the long-term USD rally.
Analysts at HSBC have told clients that the next theme in global foreign exchange will be one that sees the US dollar decline.
The view runs counter to analyst consensus from what we can see; the tenor of most research and comment that lands on our desk prices in a continuation of the cyclical US dollar bull-run for much of the year ahead.
The well-publicised expression of this theme is the decline in the euro / dollar to a 1:1 exchange rate at some stage in 2016.
But, the whole point of having an in-house research team is to make sure you beat the markets; something David Bloom, Strategist at HSBC Bank, and his team will do if correct.
The evolution of the USD bull-Run
Just where are we in the US dollar's life cycle?
Above, US dollar basket, courtesy of Bloomberg.
In a fresh research note HSBC show that the consensus for USD bullishness was clear and consensual:
- When the EUR hit 1.05 in April the consensus was that the EUR would plunge further as the Fed tightens and Greece leaves the Eurozone. Go short EUR. Wrong.
- Then, as Greek concerns faded, the consensus USD bull view morphed. The ECB ramped up its dovish rhetoric and the story was now that the Fed would hike while the ECB would cut rates and do more QE.
"Our view was and is different. The Fed called the beginning of the USD bull-run, but that was in May 2013 with Bernanke’s tapering talk. By April this year the EUR had already fallen from above 1.40 to 1.05. So this was not the beginning of the bull-run, but time to take pause and reconsider," says Bloom.
HSBC Forecasting a Falling US Dollar in 2016
Now Bloom and his team believe the narrative is turning again and the upcoming Fed rate hike will signal the last phase of the USD rally. The USD may make some gains against some EM currencies, "but we have it falling against the EUR and the JPY in 2016."
As the Fed moves closer to raising rates HSBC believe markets will start obsessing over the rate of interest rate rises and their final level at the end of the cycle.
At present this has been given little consideration thanks to the obsession with the timing of the first hike.
"The timing debate is hawkish whilst the levels debate is dovish," points out Bloom.
Now that the FX market has largely priced in a Fed rate hike for December, the narrative is swiftly transitioning to the "peak rate" debate.
That transition will, in HSBC's view, be complete on 16 December.
It is warned that shorting the US dollar now could be uncomfortable as there could be some near-term anxiety for risk assets and a slightly stronger USD in the immediate aftermath of the first Fed rate rise for 11 years.
"The market has, after all, had the best part of three years to prepare for a rate rise. We believe the market would immediately ask the "peak rate" question, which puts us back in a dovish world. This should signal a new era – one that is not singularly USD bullish," says Bloom.
In the anticipation of a Fed tightening we have had a USD bull-run.
It is argued that if rates move a little higher than expected then the USD will go up a little. "However, if at any time next year the market thinks the Fed may need to loosen in 2017, then the USD will plummet," says Bloom, "the risk/reward in 2016 is for a weaker USD. Fed rate hikes are in the price," says Bloom.
FOMC members are not tiring of stressing that the key interest rate will be raised in this cycle at a much slower rate than in earlier cycles.
Consequently, only two further rate hikes are being priced in by the market for 2016.
Inflation Could Aid the Dollar in 2016
The figures due next week on the private consumer spending deflator (PCE), the Fed’s preferred yardstick for inflation, should also give an indication of how quickly the next rate hike could follow after lift-off in December.
"One thing is clear: the stronger the inflation pressure, the faster the Fed has to increase interest rates," says Thu Lan Nguyen at Commerzbank.
Therefore, if prices rise at a sharper rate than expected, this should give considerable impetus to inflation expectations for the coming year and thus also to the US dollar Nguyen believes.