US Dollar: Fed pricing questioned as disinflation looms – MUFG

MUFG’s Derek Halpenny argues that June FOMC minutes may already be stale as weaker labour data and lower energy prices challenge the Fed’s hawkish dot plot. He sees OIS pricing as too aggressive, with rate hikes over-priced and a rate cut by March 2027 more likely than another hike. Dollar strength, he says, has been driven by rate spreads and leveraged long positioning, but this may reverse if disinflation resumes.

Fed expectations and Dollar positioning

"The FX market is increasingly being driven once again by rates spreads with our rolling correlations indicating that and the Fed rate hike pricing has been the key driver of renewed US dollar buying. A lot of this pricing appears driven by the perception that Fed Chair Warsh has been hawkish. But apart from reaffirming the pursuit of achieving the Fed’s 2% inflation goal there is limited evidence to point to of Warsh being particularly hawkish."

"The FOMC minutes from the last meeting in June will be released this evening and we would caution against reading too much into the details of the minutes given the backdrop in the run-in to the meeting on 17th June are quite different to now. The dots were likely submitted at the end of the previous week (ending 12th June) and we would argue that the breakdown of the FOMC dots would not show nine pitching for a rate hike if the meeting took place now. Nymex crude oil ended the week of 12th June at USD 85pbl, so we have declined a further 17.5% since then."

"In that regard the OIS curve looks over-priced for rate hikes. There is still close to a 30% probability priced for a rate hike at the meeting on 29th July. Given the labour market data was weaker that pricing looks too high."

"Close to 40bps of hikes are priced by March 2027 and we see a greater prospect of a rate cut rather than a rate hike by that point. We do accept the risk of re-escalation of the conflict, continued problems related to the re-opening of the Strait of Hormuz (illustrated by today’s US strikes on Iran in response to Iran’s attacks on an LNG tanker) could alter the prospect of the Fed cutting rates but assuming energy prices do not rebound sharply, the rates market looks mis-priced."