U.S. rate hike is coming, but the U.S. dollar is not responding

13 March, 2017

The greenback is weakening for a third consecutive day in early Asian trade ahead of Wednesday’s most awaited Fed meeting. Investors are almost convinced that the Fed will move forward in tightening monetary policy, with speculators pricing in 89% chance of a rate hike according to CME’s FedWatch Tool. Friday’s robust non-farm payrolls report removed all doubts and now even skeptical investors believe that three rate hikes are the base scenario for 2017. So why is the dollar  not benefiting from the shift in expectations? 

I believe the answer to this questions is simply based on “buy the rumor, sell the news” adage. The U.S. economy added 235,000 jobs in February and unemployment dipped to 4.7% from 4.8%, meanwhile wages were revised up 2.8% year-on-year from 2.6%. Despite wage growth not being robust enough, the continuous improvement in hiring will force wage growth to accelerate and diminish the slack in labor market.

The divergence in monetary policy and aggressive expected U.S. fiscal plans have been the key factors which sent the Dollar’s index to a 14-year high back in January. But recent reports indicated that European Central Bank policy makers have raised the possibility of increasing interest rates before the asset purchases come to an end, indicating that this divergence will not last much longer and investors might require to adjust their expectations.

I would rather focus on U.S. treasury yields for now as a break above 2.64% on 10-year treasuries might not only indicate that the dollar’s slide is temporary, but could be a sign that the three-decade bull bond market has come to an end, which will eventually increase the risk-free rate required by investors. And if U.S. corporate earnings growth can’t catch up, then we’re likely to see the beginning of U.S. equity markets correction.

In Europe, the U.K. divorce from the EU might become official as soon as Tuesday if the Brexit bill clears parliament later today. This will be the beginning of a very complicated two-year process, and much of it will be felt in the pound. Meanwhile Dutch voters are heading to the polls on Wednesday providing an indication on how strong the populist movement is in Europe ahead of upcoming polls in France and Germany.


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