US Dollar Likely to Rise vs. Aussie, Kiwi on Fed Rate Hike

Talking Points:

• FX Markets Mark Time Overnight as Traders Await FOMC Policy Announcement
• Scenario Analysis Hints Fed Hike to Boost US Dollar vs. Aussie, Kiwi Alternatives
• NZ Dollar Briefly Lower as FinMin English Suggests RBNZ May Cut Rate Further

Currency markets are treading water in Asia trading hours as all eyes turn to the FOMC monetary policy announcement. Chair Yellen and company are forecast to deliver the first post-QE interest rate hike. Fed Funds futures show the outcome is widely expected, with traders pricing in a close to 80 percent probability of a 25bps increase in the benchmark lending rate. The consensus seems to likewise call for dovish commentary that sets the stage for a cautious, shallow tightening cycle.

Sizing up the possible scenarios for price action after the Fed rate decision, the bar for a dovish surprise seems relatively high considering investors are already primed for timid rhetoric. On the hawkish side of the equation, the large skew in implied rate hike probabilities suggests the surprise element would need to come from either the updated set of FOMC economic forecasts, the text of the policy statement or Chair Yellen’s press conference. If the markets judge any of this to be less dovish than expected, a one-sided US Dollar rally against the G10 currencies may materialize.

In the event that the Fed delivers in line with expectations, the markets’ response may be filtered through the prism of risk sentiment trends. The Fed’s aggressive easing over the past seven years slashed returns on safer assets and encouraged a reach for yield outward along the risk spectrum. The growing proximity of stimulus withdrawal since mid-2014 might have been expected to begin reversing this dynamic. Various false starts failed gain traction however even as the greenback embarked on a long-lasting rally to reflect the looming policy shift.

This warns that a period of portfolio readjustment is still pending and may be triggered in earnest once the rate hike is finally a reality. The ensuing risk aversion may bode ill for the sentiment-linked Australian and New Zealand Dollars, sending them downward alongside stock prices, while boosting funding currencies like the Euro and the Japanese Yen. This may make for disparate USD performance, putting the benchmark unit on the defensive against the anti-risk contingent even as it rises against higher-yielding alternatives.

The New Zealand Dollar dipped briefly downward overnight after Finance Minister Bill English said exporters would prefer the currency in the mid- to low-0.60s and hinted that the RBNZ may have scope to cut rates if an on-coming drought proves severe. For its part, the central bank hinted that its easing cycle may be over at December’s policy meeting.

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--- Written by Ilya Spivak, Currency Strategist for DailyFX.com

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