Daily Commentary: EUR/USD Surges After FOMC Decision, WTI Higher

The other significant change was a reduction in the estimate of the longer-term unemployment rate to 5.0%-5.2% from 5.2%-5.5%. This is in effect a reduction in their estimate of “maximum employment” as stipulated in their mandate. By lowering this, they in effect said that they can hold off raising rates for longer than they previously thought, because it will take longer to achieve their goal of “maximum employment.” Coupled with a reduction in their estimate of inflation for this year, it means significantly less pressure to raise rates. Fed Chair Yellen said, “Just because we removed the word “patient” doesn’t mean we’re going to be impatient.” I now expect that they will not hike until the September meeting at the earliest.

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The only other significant change to the statement was the line, “export growth has weakened.” This was the only allusion to the dollar, implying that it is not yet a major concern for the Fed.

Does this change my view on the dollar? Not at all! Given the huge net long USD/short currency positions built up in the market (as I mentioned on Tuesday with regards to the Commitment of Traders report), it’s no surprise than when the Fed pushes back its estimate for the pace of tightening, people take some profits. But the fundamental facts remain: the Fed is on track to tighten policy while the rest of the world is still in a loosening mode (e.g., Sweden yesterday). While the pace of tightening was slowed, the end point (the FOMC’s estimate of the “longer run” Fed funds rate) was more or less unchanged. Moreover, with US yields still maintaining a healthy spread over euro rates, I still expect the flood of liquidity out of the Eurozone into the US. USD should still appreciate, in my view, just not at the same extraordinary pace we’ve seen recently.

SNB likely to tread carefully The Swiss National Bank (SNB) meets today. It’s likely to tread carefully to avoid saying anything that could strengthen the CHF. CHF has risen against all its G10 counterparts this year, with the exception of the surging dollar. At the same time, the country’s deflation rate of -0.8% is the lowest in the G10 and on par with that of some of the crisis countries, such as Spain (-1.2%) and Greece (-1.8%). Some people would argue that with Swiss prices totally out of line with prices elsewhere in the world (note the Big Mac in Geneva at CHF 11.70), deflation is absolutely the correct policy for the country, but that is a hard argument for a central bank to swallow. CHF interest rates are already significantly negative: 3m CHF LIBOR is -0.81%, in the middle of the SNB’s target range of -1.25% to -0.25%, and the CHF LIBOR futures forecast that rates will stay at that level for the rest of the year and only move slowly back to the bottom of that range by March 2018. I expect that after the trauma of the January CHF unpegging, they will do their best not to rile the markets while also trying to avoid doing or saying anything that might strengthen the already overvalued CHF. They are likely to adjust both their growth and inflation forecasts lower and mention the possibility of cutting rates further into negative territory if necessary, but I expect that they will reaffirm the LIBOR target at the current range and the negative deposit rate at -0.75%. The absence of any further easing measures could cause CHF to firm up a bit.

Norges Bank likely to cut The Norges Bank, on the other hand, is likely to cut rates, in my view (and the view of all but one of the 19 economists polled by Bloomberg). This was likely even before Sweden unexpectedly cut its rates yesterday, but after that move, it’s almost a sure thing – as certain as the EUR/CHF floor (that was a joke). Indeed, the Swedish move might even convince the Norwegians to move by more than the expected 25 bps. The country needs to prevent further appreciation of the NOK as it grapples with the effects of a plunge in the price of oil and the accompanying slowdown in its oil industry. When it cut rates in December, Norges Bank said that the depreciation of the NOK “is helping to dampen the effects (of lower oil prices) on the Norwegian economy and underpin inflation,” so they would clearly welcome it. NOK/SEK is far lower than the difference between the two countries’ policy rates would suggest. That implies either NOK has to strengthen considerably relative to SEK – highly unlikely -- or that Norwegian rates have plenty of room to come down. The reaction in the FX market could be to sell NOK if Norges Bank reinforces its dovish view.