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FX: Fed drives down dollar
 
Following in the footsteps of the Federal Reserve yesterday and the Bank of Japan on Tuesday, the Bank of England is also expected to leave its monetary unchanged. Therefore, the market is not expecting much on this side. However, the BoE will also provide an updated version of its forecast for growth, inflation, unemployment and wages. Out of this, the main thing the market will scrutinise is how Mark Carney’s team has been taking into account the upcoming Brexit against the backdrop of relatively solid growth. In the latest inflation report published in November, the MPC revised its growth forecast to 1.4% for 2017 compared to 0.8% three months earlier in response to a weakening pound. However, despite the fact that the BoE was overly pessimistic in its August report regarding its growth forecast for 2017, the institution expects that the country will really start to feel the sting of Brexit at this end of this year. Given the fact that the economy has been surprisingly resilient recently, we would be surprised if the BoE revises its forecast to the upside for this year.

On the inflation front, the committee lifted its projections to 2.7% by year-end, compared to 2.0% previously. Since the November meeting, the pound sterling has appreciated slightly (on a trade weighted basis), meaning that it will not justify any upside revision in the consumption price gauge. Nevertheless, the pick up in crude oil prices may provide a reason for an upside revision. All in all, barring a major surprise, this BoE meeting should go unnoticed as the uncertainty stemming from the future EU-UK relationship combined with Trump’s policy reshuffle makes the task very difficult for central banks around the globe. GBP/USD is the only G10 currency that is not taking advantage of the broad dollar weakness this morning, suggesting that the market is anxious about today's meeting.

Fed statement balanced resulting in weaker USD (by Peter Rosenstreich)

As was widely expected, the FOMC held its fed fund rate unchanged. Markets were focused on the Fed's analysis of the economic progress in the labor markets and inflation acceleration to gauge the pace of Fed hikes in 2017. Overall, the statement indicates that Fed members are calm over the status of economic improvement and are in no hurry to tighten aggressively. The statement highlighted that labor was near its mandate of full employment. On inflation, the committee indicated that levels were below the longer run objective. Yet by not declaring victory the statement took a dovish tone. While the Fed needs to keep its unbiased perspective there is a feeling that members are preparing for a potentially unforeseen reaction due to Trump's fiscal or trade policy. Judging from Trump's complete mismanagement of executive orders we are not convinced that meaningful policy can be generated. Hence, the probability that Trump will dynamically drive sustained US growth is unlikely. We maintain our forecast for two 25bp rate hikes in 2017. Yet the risk of a steep rate curve is clearly on the table. Given that the two hikes are priced into USD we continue to anticipate further weakness. With ADP coming in well above expectations markets will be watching Friday's payroll report. Given the steady drop in global FX volumes and the lower conviction in USD, we are constructive on high beta and yield EM currencies.

Source