The USD ‘Come-Back’; What’s Next? – BofA Merrill

The US dollar enjoyed the Federal Reserve’s upbeat and hawkish stance. What’s next?

Here is their view, courtesy of eFXnews:

The USD is back. Just a week ago, investors had given up, given lack of a market catalyst. They were expecting the Fed to be on hold in March and US fiscal stimulus to be postponed or weakened substantially. We have been noting very strong US data, making the case for a March hike stronger than last year’s December hike, but we were also puzzled by the mixed Fed messages. The Fed finally decided to flag a March hike this week, most likely for lack of a reason to stay on hold. A more pragmatic President Trump in his address to the US Congress may have also contributed, most likely not directly to the USD strength, but indirectly, by making the Fed less concerned about policy uncertainty. JPY and CAD have reacted the most to the new USD strength.

We have been arguing that USD/JPY* is the most sensitive G10 cross to rate differentials, as the BoJ is keeping yields at zero. We have also been bearish CAD, as the BoC is not likely to follow the Fed. The Euro found some support from investors removing their hedges for the French elections, as Macron published a sensible economic plan.

The USD could rally further. Positioning and valuation are not stretched. The market could still move to the Fed’s Dot Plot and even further after the March hike. Uncertainty from the French elections could increase closer to the event and between the two rounds. The next few months may bring some progress in the Washington consensus for tax reform. And President Trump could start considering some hawkish appointments in the Fed.