US Dollar May Rise As Fed Rate Hike Outlook Tops Market Baseline

Fundamental Forecast for the US Dollar: Neutral

Last week marked a return to the offensive for the US Dollar. The currency even managed to break out of a month-long downtrend against an average of its major counterparts. A shift in the priced-in Fed rate hike outlook brought the timeline forward for a more front-loaded tightening path in 2018. Meanwhile on the fiscal side, reports of an infrastructure-spending plan due in January emerged.

All eyes now turn to the last FOMC monetary policy announcement of the year. A rate hike is widely expected, with Fed funds futures implying the likelihood of one at over 98 percent. That means market-moving catalysts will come from the accompanying revision of official forecasts and the follow-on press conference with Chair Janet Yellen.

September’s outlook update had the Fed penciling in three rate hikes for 2018. For their part, the markets are not so optimistic. Although a hawkish drift has certainly happened recently, markets still have just one increase firmly entrenched in the baseline outlook, with some possibility of a second. If the Fed sticks to its guns, the greenback may rise as investors readjust accordingly.

Headlines emerging out of Washington DC are also an important consideration. Traders are weighing incremental progress toward passing tax cut legislation against increasingly assertive steps by Special Counsel Robert Mueller as he probes links between Russia and 2016 Trump campaign. On balance, anything that bolsters fiscal stimulus prospects is likely to help the US currency, and vice versa.