The high-flying US dollar hit a severe air-pocket in overnight trade, slumping across the board following the release of updated economic projections accompanying the US Federal Reserve’s March FOMC meeting.
With the markets all but expecting a 25 basis point rate hike — which it delivered — it was the FOMC member projections for the outlook for the Fed funds rate that really smashed the US dollar lower, coming in largely unchanged from the previous forecasts offered three months earlier.
The “dots”, as they are referred to in markets, revealed the median expectation is for the Fed to hike three times this year, and three again in 2018, underwhelming those who had been expecting the Fed would signal a faster rate tightening schedule.
Throw in stretched market positioning in long US dollar positions, and near-record shorts in US treasury futures, and this slightly dovish outcome led to a sharp pullback in US treasury yields and, as a consequence, the US dollar.
But was it really all that dovish?
While the median expectations was almost identical to that conveyed in December, Richard Franulovich, Westpac’s New York-based G10 macro strategist, notes that there was a noticeable shift in individual FOMC member forecasts in March.
“The dot plot medians are largely unchanged with 3 hikes still seen this year and next, though the 2019 median was bumped +0.125% while the neutral rate was left unchanged at 3%,” said Franulovich.
“That said, there is a hawkish migration among the “dovish dotters” with fewer participants below the median across the forecast period.
“For example, there are now 3 dots below the 2017 and 2018 median for 3 hikes, down from 6 and 7 respectively as of the last projections,” he said.
So while the median expectation was almost unchanged, the number of forecasts below the median level were significantly less that what was the case three months earlier.
Here’s the FOMC’s “dot plot” issued in December last year, compared to the one issued today.
The range does appear far more flatter now than the case three months earlier.
That could merely reflect greater confidence that the strength in the US economy is building, but it also suggests that while there were no major changes in the median expectation on this occasion, that could change by the time updated projections are released in March.
A lot will depend on upcoming economic data, along with details of the Trump administration’s fiscal stimulus plans.
Despite the slightly hawkish evolution in individual FOMC member forecasts, Franulovich says the largely unchanged median expectation, along with the “absence of any overt hawkish guidance from the Fed”, should leave the “USD trading on the back foot over the next month”.
“History suggests that JPY is likely to absorb most of the strain initially but the more lasting effect will be felt by the likes of AUD, NZD, CAD and Asian currencies,” he says.
Here’s the US dollar Index daily chart showing the sharp pullback after its recent rally.