The Fed surprised with a hawkish tone including implying a rate hike in December in a more specific manner.
The team at BofA Merrill Lynch see room for more rises from here. Here is their logic:
Here is their view, courtesy of eFXnews:
Going into the October FOMC meeting, markets were pricing the first Fed rate hike well into 2016, and expected Fed officials to acknowledge that the US data have lost steam, notes Bank of America Merrill Lynch.
“The Fed did mark-to-market that job growth has “slowed,” but they offset a dovish interpretation by removing the discussion of the restraint from “recent developments” abroad. They also reinforced the idea that each meeting is live — including December — by adding that they would be weighing whether to hike or not “at the next meeting.”
Today’s statement is consistent with a December hike, which remains our base case. However, the probability distribution is fairly flat in our view, as the Fed continues to monitor not only the data but also “global economic and financial developments.,” BofA projects.
FX: Fed holding up its end of the deal
“The USD rallied broadly following the FOMC statement. Against market expectations, the Fed maintained its outlook for “moderate” growth, focusing on the economy’s cumulative improvement since early this year, and removed the risks posed by overseas developments. This suggests a much lower bar for hiking than FX markets had anticipated amidst recently slowing data momentum. Clearly the Fed is data dependent, but with the Fed explicitly signalling December is a “live” meeting the USD will be supported not only as the probability of a hike rises, but also if the market prices a faster pace of hikes thereafter,” BofA argues.
“Combined with the ECB’s strong signal for an expansion and/or extension of QE (and potential depo rate cut) in December last week, rate differentials will once again play be an important FX driver into year-end.With our analysis suggesting much of the USD rally since 2014 driven by overseas developments (not the Fed), a significant shift in Fed expectations has room to propel the USD higher, particularly with positioning at its lowest level since the USD rally began.
While Fed hikes could take some pressure off of G10 central banks from easing, it also suggest higher beta currencies could struggle if risk sentiment takes a hit or commodity demand comes down amidst USD strength. The key question is if the US economy is strong enough to handle a stronger USD,” BofA adds.
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