Expected increase in the inflation rate and improved FOMC projections enhance investors’ interest in the US dollar

How long is the Fed going to play with fire? When the unemployment rate is down to its eighteen-month low, and the inflation rate has, for the first time in years, reached its target, the central bank declares its willingness to be patient. Will it really allow the economy to get overheated and will be too late to start aggressively raising the federal funds rate, pushing the US economy down to recession? Jerome Powell's predecessor in the Fed’s Chair, Janet Yellen had been studying correlation between unemployment and inflation for three decades; she believed that if the first indicator fell down below the balance level (the Fed’s estimate at 4.5%), PCE growth would speed up. In the first case, the inflation growth became real.

The derivative market indicates 96% probability of the federal funds rate increase at the FOMC meeting on June 12-13. The chances for four monetary restriction acts in 2018 are up at 45%. Wall Street Journal experts also vote for this scenario. In March, 12 out of 15 FOMC representatives believed that the interest rate would be increased three or four times. Investors expect the median forecast to be up at four times at the current meeting. According to Goldman Sachs, the Fed will restrict monetary policy three more times in 2019.

FOMC projections for the interest rate

Source: Financial Times

The US dollar supporters are also encouraged by the expected rise of GDP and inflation. The mass fiscal stimulus worth $1.8 trillion, according to Atlanta Fed, is able to speed the US economy’s growth up to 4.6% (!) in the second quarter, from 2.2% in the first one. Bloomberg experts expect that CPI will be up at 2.7% in May due to the oil prices rise. Yes, the Fed has officially stated recently that it would accept inflation, symmetrically relative to the target. The matter is up to what level.

The central bank will hardly be stopped by the international risks, like it was in 2016. Although Donald Trump rejects the G7 final communiqué, and Christine Lagarde said trade wars would threaten global economy, the IMF retained its optimistic forecast for global GDP at +3.9% in 2018. Italian crisis is almost a part of history after Italy’s finance minister Giovanni Tria has not only repeated his mantra that leaving the euro is out of the question; he has also stated that Rome will be working to reduce Italy’s national debt (130% of GDP). Italy 10-year bond yield has dropped down to 2.84%, and investors let out a sigh of relief.

Dynamics of Italy government bond yield


Source: Trading Economics

Finally, the historic meeting of the USA and North Korean leaders in Singapore has improved global risk appetite and become the evidence that there are no reasons to worry about international events. The Fed will go on with monetary normalization, and so, I retain my forecast for EUR/USD middle-term consolidation in the range of 1.15-1.2.

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Price chart of EURUSD in real time mode

Dollar Draws the Fire

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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