Fed unlikely to meet market's high expectations for hikes

Matthew Ryan, CFA Ebury

In the world of FX, the US Dollar has reclaimed its mantle as king, despite the fading geopolitical risk that would ordinarily be followed by an unwinding in dollar safe haven flows.

We have been somewhat surprised by the strength of the greenback in the past month or so. We do not think that the Fed will meet the market’s now high expectations for hikes.

We have upgraded our US dollar forecasts against most of the major currencies in the past fortnight. Our call for a mild grind lower in the dollar versus most of its major and emerging market counterparts remains intact, however. Iran de-escalation remains our central scenario, despite the latest flare up, with the safe haven unwind yet to be fully realised. We do not expect a full hiking cycle from the Federal Reserve, with the energy relief and falling consumer confidence set to keep a lid on inflation.

We also contest that dollar long positioning appears somewhat crowded. A less hawkish surprise from the Fed at its 29th July meeting could trigger a fairly rapid unwinding in dollar longs.

The US labour market remains robust, yes, but loose enough that workers are not able to demand sizable salary hikes, which should ease pressure on inflation, and unless and until we see clearer signs of a passthrough to core price pressures, we think that the Fed will proceed with caution - our base case favours no rate hikes in 2026.

The latest developments in US-Iran relations raise the million-dollar question of whether this marks a complete breakdown in negotiations and a return to hostilities, or merely a temporary setback. While we side firmly with the latter, and see this as a classic play right out of the pages of Trump’s Art of the Deal, we do expect the heightened uncertainty to be reflected in an increase in the geopolitical risk premium.

That means a greater aversion to risk across markets, higher oil prices and another bout of safe haven flows into the dollar, at least until we receive news of a thawing in US-Iran tensions.

Author

Matthew Ryan, CFA

Ebury

Matthew is Global Head of Market Strategy at FX specialist Ebury, where he has been part of the strategy team since 2014. He provides fundamental FX analysis for a wide range of G10 and emerging market currencies.

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