Federal Reserve of the United States (Fed) seems to be headed for the beginning of a tightening cycle as Mrs. Yellen stated during her Jackson Hole speech that she sees a stronger case for a rate hike.
This should come as no surprise as both jobs creation and inflation seem to move into the right direction and the U.S. economy is doing way better than its major counterparts.
If in Europe we see Bank of England cutting rates and starting a new quantitative easing program and European Central Bank fighting low inflation and economic growth with negative rates and an ongoing quantitative easing program as well, the U.S. economy is moving in the opposite direction.
Growth rate picked up, jobs are being created for more than seventy consecutive months, Core CPI (the favorite indicator for Fed to measure inflation – it does not take into account food, energy and transportation prices) ticks higher (even though it is far below the 2% target), ISM Non-Manufacturing prints solid above the 50-gauge line – all these call for a gradually pick up in interest rate.
The problem with the Fed is not the fact that they have to hike rates, but the timing here is important as well. One wants to be seen as a proactive bank and not a reactive one and this can only be accomplished if a tightening cycle starts before inflation reaches the 2% target.
U.S. elections may see this favorable mix that is going on in the economy setting back a bit, but the general feeling is that the U.S. economy is strong enough to take any shock and higher rates are a given.
Ahead of us, there is the NFP (Non-Farm Payrolls) release on Friday and if the strong jobs creation trend is to continue, we should see another good print.
The U.S. dollar should only move higher and if I were to pick some favorites from the major currency pairs, I would say that the AUDUSD and EURUSD are the ones to travel the most.
The reason for that is the fact that there is a sharp contrast between what the RBA (Reserve Bank of Australia) and ECB are doing from a monetary policy point of view and what the Fed is expected to do.
There’s nothing more important for a currency pair than strong divergent roads between the two central banks that represent the pair.