Last week the US Federal Reserve hiked interest rates for the second time in three months, something that hadn’t been seen in well over a decade.
However, despite the acceleration in the Fed’s monetary policy tightening schedule, the US dollar still fell, and has continued to do so since.
It’s a scenario that’s not unheard of, but it is slightly unusual nonetheless.
While disappointment that the Fed didn’t signal a faster hiking cycle in its latest forecasts was one factor, along with nervousness about the ability of Donald Trump to deliver on his pre-election promises, there’s another reason why the US dollar has been under pressure.
Financial markets are now bringing forward the expected timing of monetary policy normalisation, beginning in the Eurozone and UK.
This excellent chart from ANZ rate strategists Martin Whetton and Katie Hill demonstrates that shift in sentiment perfectly.
It shows the number of months until the first hike in interest rates is expected by the European Central Bank (ECB) and Bank of England (BoE).
Quite a turnaround, right?
“As recently as October 2016, markets were expecting the ECB and BoE to remain on hold for another five years,” Whetton and Hill wrote.
“The better growth and inflation atmospherics have since driven a sharp reassessment of the outlook.”
And that reassessment of policy normalisation in Europe is doing the Fed a massive favour, they say.
“This is helping to take pressure off the USD, providing cover for the Fed to continue to hike without excessively tightening financial conditions.”
As shown in the chart below from ANZ, after largely moving in lockstep in the prior five years, there has now been a sharp disconnect between expectations for where the Fed funds rate will sit in one year’s time and movements in the US dollar index.
Since late last year, the former has ratcheted higher while the US dollar has actually fallen.
As Whetton and Hill allude, this is providing a gift to the Fed, allowing them to lift interest rates without adding the additional burden on the US economy of a higher US dollar.