Goldman: Structurally Bullish USD, Tactically Cautious Into FOMC

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The 'taper tantrum' turns one year old tomorrow (June 18), but unlike a year ago, markets have positioned for at least a modestly more hawkish FOMC tomorrow, says Goldman Sachs.

"While it is hard to be certain of positioning, the potential for a hawkish shift is at the top of the agenda in many of our client conversations. Fed funds futures are pricing 50bp in tightening through end-2015 (beyond normalizing effective Fed funds to 25bp), up from around 30bp two weeks ago and the most since the days immediately after the 'dots' surprise at the March FOMC," GS clarifies.

Into the FOMC:

Tactically, that makes GS cautious going into tomorrow's FOMC, while recognizing, however, that this view is finely balanced.

"Although we are structural Dollar bulls, for reasons we spelled out recently, this leaves us tactically cautious going into tomorrow's FOMC. Exhibits 2 and 3 show that the fortunes of the Dollar are closely linked to the 2-year rate differential, which itself is a function of the Fed’s forward guidance. Since we think the Fed could lean on front-end interest rates for longer than markets expect, this leaves us cautious for now," GS projects.

"In the short term, the ability of the Dollar to strengthen meaningfully depends on the willingness of the Fed to let front-end rates move higher. Our assessment is that the Fed is not yet ready to let this happen," GS argues.

Beyond the FOMC:

"Moving away from the FOMC, one of our strongest convictions remains EUR downside. In particular, we had flagged in recent weeks the potential for EUR/GBP to move substantially lower to around 0.70 – 0.76, a range we identified on the basis of the 2- and 5-year rate differentials," GS adds.

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