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"We became Dollar bulls in April 2014, forecasting that the greenback would rise 15 percent against the majors. We reasoned that slack was diminishing, allowing the Fed to normalize monetary policy, which would move rate differentials in favor of the Dollar. In the event, the Dollar rose more and faster than we expected, but for a different reason. BoJ and ECB pursuit of QE drove the Dollar up, while the Fed has done little to normalize policy, amid signs that it is increasingly targeting the currency (Exhibit 1).
Following recent Fed speak, which first raised hopes of a September hike only to dash them, we revisit prospects for the Dollar at a time when many see little, if any, upside. We distance ourselves from the near-term debate over September versus December and, instead, work back from the medium term. Through mid-2019 interest rate futures price only two hikes, which is low even by the standards of the recent R-Star debate.
The medium-term outlook for the Dollar is therefore very supportive, even if this hiking cycle falls short of the historical template. In the short term, the discussion over September versus December ignores that markets price only 15 bps for the two meetings combined. Given that Vice Chair Fischer talked about the possibility of two hikes this year, one hike is very much on the table.
The short-term picture is therefore constructive as well, with our favorite implementation long $/CAD into the October MPR meeting (Oct 19). This cross could approach our 12-month forecast of 1.40 by year-end.
We also like long $/JPY, given that long Yen positioning is extreme and markets are overdue for a re-think on the BoJ being out of bullets. We target 110 by year-end.
Finally, it is time to re-initiate short RMB positions, given that Dollar strength remains a stumbling block for China's currency".
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