Dollar bulls say Europe’s 1.1 trillion euro ($ 1.23 trillion) bond-buying plan will bring the Federal Reserve a step closer to raising interest rates before the year’s out.
By pumping cash into global markets, the European Central Bank may clear the way for the U.S. to tighten its own money supply without stoking volatility, according to Citigroup Inc. and Bank of America Corp. As Fed officials start a two-day policy meeting, the greenback is extending a rally that’s taken it to a more than decade-high versus a basket of its peers even as bond investors express less conviction about the timing of an U.S. central bank’s first rate increase since 2006.
“We’ve been expecting dollar strength, and it’s coming quicker than we thought,” Steven Englander, the head of Group of 10 foreign-exchange strategy at Citigroup in New York, said by phone on Jan. 23. Fed officials “may feel they actually have to advance the first tightening rather than put it off.”
Money has flooded into dollar assets in recent months as the world’s largest economy outperforms its developed peers and the Fed prepares to raise its main interest rate from the zero-to-0.25 percent range it’s been in since 2008. That makes the dollar more valuable to investors, particularly as central banks from Japan and Canada to Europe debase their currencies by easing their monetary policies.
The anticipated timing of that first Fed increase inched forward as the ECB unveiled its government-bond purchase program. Investors now expect the U.S. central bank to boost borrowing costs from near zero in October, after betting on a December increase just a month ago, according to futures prices compiled by Bloomberg.
Some 45 percent of 53 economists in a Bloomberg survey released Monday said the central bank will raise the benchmark lending rate in June. Six percent said July, while 30 percent said the Fed will wait until September for the first increase since 2006. Fed officials last month said they expect to raise the rate this year.
When the ECB finally laid out its plans on Jan. 22, surprising investors with the scope of the purchases, the euro responded by tumbling to an 11-year low. It touched $ 1.1098 on Monday, the weakest level since September 2003, after the anti-austerity Syriza party won Greek elections that investors speculated may lead the country out of the euro. The common currency was at $ 1.1334 at 9:01 a.m. in London, having fallen about 7 percent this year.
Credit Suisse Group AG, the largest Swiss bank, cut its 12-month forecast for the euro to $ 1.02 from $ 1.05 after the ECB announced quantitative easing, or QE.
“All of these countries are easing, or in an environment where potential immediate easing action is a real possibility,” Shahab Jalinoos, the global head of foreign-exchange strategy at Credit Suisse in New York, said by phone on Jan. 22. “You don’t need to price in a near-term Fed rate hike. All you need is a Fed that’s neutral and you see the dollar outperform.”
Intercontinental Exchange Inc.’s U.S. Dollar Index — which tracks the currency against six major peers — is headed for a seventh straight monthly advance, after surging 19 percent since the end of June. It climbed to 95.527 yesterday, the highest since September 2003.
Strategists have rushed to keep up with the gauge’s strength, boosting their year-end forecast to 96.6 from 94 on Jan. 16. Before that, the outlook hadn’t changed since early December.
Soft wage growth and consumer prices have the U.S. central bank expressing caution about when to embark on a return to tighter monetary policy. Fed Chair Janet Yellen said in November that “normalization could lead to some heightened financial volatility.”
JPMorgan Chase & Co.’s Group of Seven Volatility Index, which measures currency price swings, has jumped to 10.95 percent, from an all-time low of 5.11 percent in July, when the dollar started to rally.
As the Fed ponders tightening policy, the Bank of Japan is still seeking new ways to pump stimulus into its economy to complement a record bond-purchase program. Last week, Canada and Denmark unexpectedly reduced interest rates to boost growth and stave off the crippling effects of deflation.
By pumping more cash into global markets, Europe and Japan are effectively replacing the money that the Fed already drained out of the system last year when it ended its own QE program, Citigroup’s Englander said.
Englander’s company is the world’s biggest foreign-exchange dealer and sees the 19-nation euro falling an additional 3.9 percent to $ 1.08 by year-end. It has the equal strongest prediction on the dollar versus the yen in a Bloomberg survey of more than 60 strategists, forecasting a gain of almost 12 percent by Dec. 31.
To Bank of America, easing elsewhere in the world will give the Fed confidence to signal higher rates more quickly than previously thought. The U.S. lender cut its year-end euro forecast to $ 1.10 from $ 1.20 after the ECB’s QE announcement.
Looser monetary policies in Europe and Japan allay concern that Fed increases will “create a vacuum in global liquidity,” David Woo, the head of global rates and currencies at Bank of America in New York, said by phone on Jan. 23. “All else being equal, the Fed’s going to be more hawkish than dovish.”
To contact the reporter on this story: Andrea Wong in New York at [email protected]
To contact the editors responsible for this story: Dave Liedtka at [email protected] Paul Armstrong, Nicholas Reynolds