USD upside risks should be contained to near-term – MUFG

Analysts at MUFG Bank point out that their assumption of ‘more of the same’ from the Federal Reserve meeting this week was wrong and the outcome has already been considerable and there are clear upside risks to the US dollar. They argue though that the Fed will not want to see a repetition of what happened in 2013 when inflation expectations fell back sharply after the ‘taper tantrum’. According to them, Fed's officials next week will try and reassure markets on its new more dovish monetary policy strategy announced last year that is already being doubted.

Key Quotes:

“The FOMC fallout in FX was clear with DXY up 2.0% since the announcement on Wednesday. The basis of our USD bearish view through the remainder of this year (DXY 87.000 at year-end; now a 5.3% drop) was that the Fed would be ultra-cautious in moving away from its current monetary stance given the new monetary policy framework announced last year that moved the Fed to an inflation averaging regime that effectively meant a much later than previous move away from monetary easing. Should this now be discarded as a view? There is a clear and obvious risk of that now and we will have to adjust our USD weaker forecast profile. For now the shift in the DOTs is getting much more focus than the lack of shift in the guidance of tapering with “further substantial progress” needed before tapering can begin.”

“We would argue though that the Fed will not want to see a repetition of what happened in 2013 when inflation expectations fell back sharply after the ‘taper tantrum’. We now have a ‘DOTs tantrum’ and we suspect Fed Chair Powell and others next week will try and reassure markets on its new more dovish monetary policy strategy announced last year that is already being doubted.”

“The fallout from the surprise shift in the DOTs profile could well see the dollar extend further over the short-term. However, an abundance of liquidity and possible Fed communication intervention should mean we avoid a sustained ‘DOTs’ tantrum!”