Whether or not there was a secret “Shanghai Accord” to push the dollar lower, the outcome has been clear: moments ago, the USD as measured by the Bloomberg Dollar spot index just dropped to the lowest level since June 22, long before the Fed commenced its rate hikes, indicating that the market is, at least for now, convinced that the Fed is “one and done” and that Eric Rosengren’s warning that rate hikes will accelerate from here is nothing but a hollow threat.
This was perhaps to be expected: just one month ago Goldman was pounding the table on how there was “no central bank conspiracy” to push the dollar lower, and how clients should keep buying the USD because “Goldman is right, and the market is wrong.”
Once again, Goldman was wrong and the market is right. It also suggests that Goldman was wrong about the “central bank conspiracy.”
And as has been the case over the past year, a weaker dollar means stronger oil, and sure enough moments ago WTI spiked to new post-Doha highs, above $41/barrel even as production continues unabated and as Kuwait is slowly resolving its supply cut as a result of this weekend’s oil worker strike.
But the most important outcome of the collapsing dollar is that as Goldman writes, this time correctly, the company’s own Financial Conditions Index “is now at the easiest level since August 2015, when China devalued the CNY. Each of the key components—long rates, the dollar, equity prices, and credit spreads—has retraced most or all of its prior deterioration.”
Following Monday’s equity and credit rally, we estimate that our GS Financial Conditions Index (GSFCI) is now at the easiest level since August 2015. Exhibit 1 shows that the index has eased 115bp since the January 20 peak. Each of the key components—long rates, the dollar, equity prices, and credit spreads—has retraced most or all of the prior deterioration.
To Goldman the easier conditions arising from the weaker dollar “equates to an underlying growth pace of about 2¾%. With an FCI impulse of about zero in the second half of 2016 and +¼pp in 2017, this simple calculation would imply growth in the 2¾%-3% range in coming quarters, well above our current 2-2¼% forecast.”
Maybe Goldman will be correct about this, but where it certainly remains wrong is in its forecast for three more rate hikes in 2016. This is what it said:
Although the risks to our three-hike forecast in 2016 are clearly on the downside, we expect the FOMC to tighten monetary policy by significantly more than discounted in the bond market. All else equal, this should lead to a renewed tightening of the FCI if we are right about the Fed. Nevertheless, we think financial conditions have turned from a significant downside risk to our growth forecast in early 2016 to a moderate upside risk at present.
What does the market think? That Goldman is dead wrong. As the following table shows,the probability of a rate hike at the June meeting is only 17.6% and barely rises to above 50% by the December meeting. In other words, the market is saying just one more rate hike by the Fed in 2016, most likely at the December meeting.
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