US Dollar Outlook

1-3 Month Outlook - A hike around the corner 

What more is there to say about the Fed's "will they/won't they"? Investors are tired of talking and hearing about it. Many argue the Fed should just get the first hike over and done with including several EM central banks. The latest FOMC statement appeared to show the Fed also leaning in that direction. Having pushed the first 25bps hike all the way back to August 2016, markets are now priced for April next year. As that draws nearer, USD is expected to trend higher, particularly against JPY. 

The US economists are still calling for a hike in December though over a slightly longer horizon, it should not matter whether the Fed starts in December or March. The point is the first hike will dispel fears that the US may not have time to tighten before it is hit by its next recession. There are also some who argue that USD rallies ahead of the first Fed hike and sells off after. This holds on average, but it masks wildly different reactions to Fed tightening cycles. The degree of uncertainty heading into this cycle and the flatness of the forward curve means USD should do well in this tightening cycle. 

"We have revised our forecasts higher, mainly reflecting higher chances of easier policy elsewhere (i.e. policy re-diverging). Long USD positioning is also lighter than it was at its peak in the summer (though not quite as light as in early October)", notes RBC Capital Markets.

6-12 Month Outlook - US able to support strong USD 

The US is better placed than most countries to shoulder currency appreciation. While net trade has been a drag on US growth in recent quarters as the Fed likes to remind us. The culprit is weak global demand. If monetary easing is successful in boosting domestic demand in other parts of the world (Europe, China, Japan), the US will also be a beneficiary, despite stronger USD. And because a lot of global trade is denominated in USD, the US sees lower exchange rate pass-through than other countries (a recent academic study estimates it is a quarter to a third of pass-through in EM countries). In fact 93% of US imports are denominated in USD. That means both on the growth and the inflation front, USD has room to rise. 2016 is also election year. One thing that will be watched is the possibility for tax reform, following Paul Ryan being elected House speaker. With many US companies parking earnings abroad to avoid taxation on repatriation, a significant tax reform also has the potential to be USD positive.