The Fed went dovish (here are 5 points) and the dollar certainly tumbled. What’s next for the greenback? Here is the view from Bank of America Merrill Lynch:
Here is their view, courtesy of eFXnews:
FOMC maintains a dovish stance. The Federal Open Market Committee (FOMC) not only did not hike today as widely expected, but it put a more dovish spin on its communications: modest downward revisions to near-term forecasts, retaining language about global and financial risks, continuing to monitor inflation and, most notably, dropping the likely number of rate hikes this year down to just two, from four, in the December Summary of Economic Projections (SEP). This dovish tilt is a bit of a surprise to us, given how the data — particularly on inflation — have shown signs of improvement of late. An April hike seems rather unlikely after today’s meeting, but we are comfortable with our expectation for the next hike in June, followed by December this year.
FX: Dollar disconnect with fundamentals to persist with Fed signal muted. The USD rally in recent days suggests the market was preparing for a more optimistic tone, and potentially a shift back to ‘balanced risks’, evidenced by the significant selloff post-statement. The greater-than-anticipated lowering of the dot plots (2 less hikes in ’16 and ’17), cautious inflation language, and the inclusion of language that “global economic and financial developments continue to pose risks” goes against the stabilization in markets and financial conditions witnessed in recent weeks.
With the Fed’s policy signal muted for now following today’s statement, the dollar’s dislocation with rate differentials and fundamentals is likely to continue for now, and will be more beholden to movements in risk and commodity markets. As a result, higher beta FX will likely outperform versus the dollar in the near term unless data reinforce expectations for a June hike.
Despite greater uncertainty about the near-term outlook, the two hikes we expect this year will still support USD outperformance within G10 (except versus the Japanese yen) with many other countries easing policy further, most notably the European Central Bank.
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