Dollar to force rates higher? - Westpac

Analysts at since the beginning of November 2017, the DXY US dollar index has fallen from almost 95 to near 89 currently (–6%) amid strengthening expectations for global growth and Euro Area/ Japanese monetary policy. 

Key Quotes:

"While expectations for robust global growth are justified, those for a material change in the stance of monetary policy in Europe and Japan are not. Consequently, we still expect a circa 7% rally in the US dollar (DXY) in 2018, but that will still leave its level below our prior profile. For the US dollar, there are considerable risks in both directions. 

The market response to protectionist comments this week from the Trump administration highlight that, amid a robust global economy, US protectionism is likely to be to the detriment of their currency. Further government shutdowns will also affect confidence negatively. That said, a weaker US dollar and December’s tax reform package loom as upside risks for inflation, growth and therefore the stance of monetary policy. 

As we have highlighted regularly, the terminal fed funds rate for this cycle will depend on how the stance of monetary policy influences overall financial conditions. 

Three hikes would see the fed funds rate above neutral and would also be followed by balance sheet normalisation at maximum effect in Q4 2018 and Q1 2019. Financial conditions should therefore tighten materially and weigh on growth. However, if term yields remain suppressed and/or the US dollar fails to rally as we expect, then the current rate hike cycle could have further to run. At this time, this is not our base case."