USD: All eyes on Brainard - MUFG

Derek Halpenny, European Head of GMR at MUFG, notes that the dollar has recovered some of the losses fuelled by a run of some weaker than expected data as the market reverts back to the reality of the Fed possibly raising rates at its meeting next week.

Key Quotes

“The dollar gain on Friday was fuelled by the comments from Boston Fed President Rosengren who expressed concern about rates remaining too low for too long. Most significantly, he argued that the economic growth phase could be prolonged by acting earlier given the risk of a more abrupt rate increases possibly being required if hikes are delayed too long.

We also had comments from Governor Tarullo and Dallas Fed President Kaplan. Tarullo was certainly more cautious and appeared more in favour of waiting while Kaplan signalled his support for Yellen by repeating exactly her view from Jackson Hole that the “case for a rate hike has strengthened in recent months”. That simple repeat of Yellen’s view indicates that Rosengren does not place too much weight on the run of weak data that has come since Jackson Hole. But while these comments have helped shift expectations of a rate hike next week, pricing suggests the market is not yet convinced and hence the Fed speakers today will also be important in shaping expectations. Atlanta Fed President Lockhart, Minneapolis Fed President Kashkari and Governor Brainard all speak today on the last day before the blackout period begins ahead of the meeting on 21st September.

We calculate that the September fed funds futures price implies a probability of a rate hike next week at 24%. The 2-year UST bond, yielding just 0.78% this morning is only 15bps above the 0.73% effective fed funds rate that would probably prevail if the Fed hikes next week. These levels essentially point to a market still very sceptical of a rate hike or certainly very sceptical of the Fed being able to follow a move this week with any further hikes. We suspect Brainard may well indicate a shift from her more usual dovish stance that will confirm to us the strong likelihood that the Fed will act next week. That points to continued upside risks for the dollar. The DXY index has only just about retraced the drop triggered by the weak ISM non-manufacturing index last Tuesday pointing to ample upside scope if Brainard confirms to the markets the likelihood of action.

Data that could sway the market will only come toward the end of the week with retail sales for August on Thursday and the CPI inflation data on Friday. Control Group retail sales are expected to rebound following the flat print in July while the core annual CPI rate is expected to remain at 2.2%.”