Fed stuck to an upbeat view on the economy – Westpac

Sean Callow, Research Analyst at Westpac, explains that last week they pondered whether the US dollar was poised for a comeback, supported by higher yields as the Fed stuck to an upbeat view on the economy and the need for further rate rises and this has largely proven the case over the past week, with USD rising against most of the G10, especially JPY (1.4%).

Key Quotes

“USD/JPY is typically the G10 pair most sensitive to the outlook for US interest rates.”

“Admittedly, there has not been follow-through on the 10 year Treasury note yield, perhaps constrained by the soft Q1 GDP data and a dip in inflation. But this week’s FOMC statement made clear that the Fed is not concerned about the long-flagged Q1 GDP slowdown, describing it as likely to be “transitory”. Forecasters agree, with consensus 2.6% and the Atlanta Fed above 4%.”

“The FOMC also spun recent inflation data as being no cause for concern. It noted that overall inflation is close to the 2% target (PCE deflator 1.9% y/y), while conceding that underlying inflation is “somewhat below” 2%. The Mar core PCE deflator slipped to 1.56% y/y, a 1 year low. The Fed’s lack of concern over growth and inflation (not to mention payrolls) leaves it on track for a June rate hike.”

“Pricing for such a move (which remains Westpac’s base case) is around 72% (CME data). So long as the April employment report is at least reasonable, this pricing should edge higher, as the post-meeting flurry of Fed commentary reinforces the message that rates need to rise by more than markets are pricing.”

“The euro has outperformed over the past week, about steady against USD, no doubt helped in part by optimism that centrist Macron will defeat hard-right nationalist Le Pen for the French presidency on Sunday. Equity volatility has slumped since the first round vote – see chart. This may help stem AUD losses against a strong dollar.”