Dollar Traders Look Past Fed Hawks to Canvas of Dovish Dots

Morgan Stanley's Redeker Sees Potential 4-5% Dollar Drop
  • Greenback tumbles even as central bank signals 2016 rate hike
  • U.S. currency’s year-to-date drop exceeds 4% after Fed

Dollar bulls banking on the Federal Reserve to signal at least one interest-rate increase by year-end got their wish -- and were still disappointed.

The currency slid against almost all of its major peers Thursday, a day after the U.S. central bank left its policy rate unchanged and projected a boost by year-end. That’s because it also scaled back the outlook for increases in 2017 and beyond. For dollar bulls, it was the latest in a series of disappointments this year as the Fed again stood pat, undermining bets the greenback would strengthen while central banks in Japan and Europe further debased their currencies with stimulative policies.

“There’s not much more upside for the dollar,” said Constantin Bolz, a foreign-exchange strategist at UBS AG’s wealth management unit in Zurich. “We have now reached this point of maximum divergence in monetary policies.”

The Fed’s “dot plot,” which it uses to signal its policy outlook, shows that officials expect one quarter-point rate increase this year, followed by just two next year. In January, policy makers were calling for four hikes this year followed by another four in 2017. The announcement further dims the outlook for the dollar after a more than 20 percent surge since the middle of 2014 gave way to a 4 percent slide this year.

The Bloomberg Dollar Spot Index, which tracks the greenback against 10 major peers, fell 0.5 percent as of 9:56 a.m. in New York, taking its slide over the past two days to more than 1 percent.

Weaker Outlook

The Fed won’t raise rates in December and the dollar will suffer more losses, said Hans Redeker, Morgan Stanley’s chief global currency strategist in London.

"The U.S. dollar decline has more weeks to go, we think about two months," Redeker said in an interview with Bloomberg Television. "We suggest that the U.S. dollar will extend its decline, index-wise, between 4 percent to 5 percent."

For dollar bulls, the disappointments keep adding up. At the start of the year, the consensus was for the U.S. currency to strengthen to $1.05 per euro and 125 yen by year-end -- instead, it has weakened more than 3 percent to $1.1239 per euro and 16 percent to 100.80 yen, forcing analysts to cut their forecasts to keep pace.

The Fed decision comes after the Bank of Japan announced a more flexible approach to expanding stimulus, while seeking to control bond yields across different maturities. Emerging-market currencies dominated gains on Thursday, with South Africa’s rand and the Korean won both climbing at least 1.2 percent.

Slowest Tightening

Regardless of when the Fed moves next, dollar bulls face the prospect of the slowest and shallowest tightening cycle in recent history, based on the market for overnight index swaps, which reflect expectations for the fed funds effective rate.

"The risks are skewed to the downside," said George Davis, chief fixed-income technical analyst at Royal Bank of Canada’s RBC Dominion Securities unit in Toronto. "If we’ve already priced in a move by the end of the year and we’re looking at a gradual path in 2017 and 2018, that will present headwinds for the U.S. dollar.”

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