Five Fed Scenarios & The Market Impact

 1. A surprisingly hawkish Fed: We define this as a rate hike combined with no downgrade of future terminal rate projections. In this case we would expect the USD to resume trend appreciation and rally by at least 5% by the end of the year on a broad TWI basis.


2. The Fed hikes but qualifies this by producing suppressed terminal rate expectations among other caveats: This should allow the USD to gain ground in line with our existing relatively muted forecast profile for the next 3 months. But the upside move is likely to be short and sharp as the subsequent period of suppressed rate expectations will reduce the potential for rate-differential and by extension FX volatility and trends.


3. The Fed does not hike but makes it clear there is a high chance of a hike this year, while keeping its terminal rate expectations similar to current projections: We would expect a similar reaction to Scenario #2 above. But to the extent that the market can continue to hope for a protracted Fed hiking cycle and material monetary policy divergences persisting with other countries, there may be more lasting opportunities to establish USD longs than the case with Scenario #2.


4. The Fed does not hike, it makes it clear there is a high chance of a hike this year, but still lowers its terminal rate projections: We would a modest USD sell-off of around 2-3% over a period of a couple of 1-2 weeks as the market would wonder if the Fed ever gets into a position to hike rates at all. We would use this as an opportunity to buy USD vs currencies of countries where a policy ease is likely (for example AUD or JPY) or where there are underlying and unsolved fragilities (such as EM currencies like BRL or TRY).


5. A clearly dovish Fed that takes the idea of rate hikes off the table for at least 6 months: This would prove a material shock to the market and should result in material losses for the USD on a TWI basis of at least 5% in the remainder of 2015. This scenario would stress our existing USD-bullish forecast profile unless we were to expect relatively rapid dovish tilts in response by other central banks.

6 thoughts on “Five Fed Scenarios & The Market Impact”

  1. So basically, dollar’s rally is directly co-related with increase of FED rate. And what will be the effect on Indian markets, plz.

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