Hawkish Fed catches markets by surprise

Markets were taken by surprise yesterday by the relatively hawkish Fed message: the FOMC revised higher the median projections of their expected rate path by 25bp for end-2015 (from 0.75% to 1.0%) and by 50bp for end-2016 (from 1.75% to 2.25%). This is significant since the market was pricing a rate path that was even lower than what the Fed was projecting before this meeting. Notably, new chairman Yellen may have been more explicit than planned when she replied to the question of how a “considerable period of time” after the end of tapering to the first rate hike should be interpreted: she replied “something on the order of around six months”. Certainly not what the market was expecting: fixed-income markets sold off extensively with 5Y Treasury yields up around 15bp, and EUR/USD fell one big figure to now trade just above 1.38.

Today FX markets will be focused on digesting the Fed messages from yesterday. Albeit Yellen tried to downplay the importance of the higher rate projections laid forth, it is now very likely that the US money-market curve will be less well anchored going forward which could eventually pave the way for more broad-based dollar strength. While we cannot rule out that this could prove a turning point for EUR/USD, we do not think a massive sell-off will be seem form here in the near term. First, the Fed may in the months ahead try to tone down expectations of when the first rate hike should be expected as the “six months” indication may have been a slip of tongue at Yellen’s first press conference. Second, we stress that the likely lack of significant action from the ECB will remain a headwind for EUR/USD to go much lower in the near term.

Still, yesterday's messages from Yellen highlight that monetary policy should be a dollar supportive factor in H2. In terms of our EUR/USD 12M matrix projecting implications of combinations of ECB/Fed outcomes we are now leaning from the mid-column towards the left-hand side in terms of Fed policy as Fed has now signalled earlier rate hikes than previously (see p. 3 from our recent FX Trends: Central bankers push 'snooze' button).

Note that yesterday we closed down a few trades from December's FX Top Trades 2014, a recent trade on CAD, as well as a long-standing call for substantially lower levels in EUR/USD, which now seems out of reach in the near term.

As expected, the SNB kept rates unchanged and maintained its 1.20 EUR/CHF floor in connection with today’s monetar policy meeting. See page 2 for more details.