The Fed is getting it wrong, say Morgan Stanley, with a chunk on expectations and yield curve flattenings driving the dollar weaker:
And in words/question form:
Fed policy mistake? Since the start of this year, US inflation expectations have fallen more than in other G10 economies, seeing the 10-year breakeven declining from 2.07% to 1.68%. Consequently, the US 2s10s curve has flattened as investors have adopted the view of the Fed getting it wrong again. Last week, the Fed hiked rates by 25bp to 1.25%, firmed plans to shrink the balance sheet this year and underlined its intention to hike rates by an additional 100bp by end-2018.
Within the G10 context, it was the relative shift of yield curves determining currency trends, pushing the USD lower by 6% since the start of this year (Exhibit 2). The US yield curve flattened the most within G10, while EMU and Norway’s curves have steepened in light of the ECB and Norges Bank staying accommodative (Exhibit 3). The market’s verdict seems clear – it regards the Fed’s current approach as too tight.
Their point being that growth expectations at the start of the year have proved… off: “Falling tax revenues, the flattened yield curve and banks seeing low loan demand suggest the US is heading towards weaker growth.”
So “the markets increasingly disagree with the Fed. Despite the Fed projecting it will hike rates by 100bp by the end of next year, the markets are only pricing in 37bp.”
More in the usual place.
Term premia scramble the Fed’s dot plot – Gavyn Davies