Expectations for US Federal Reserve interest rate hikes previously led to sharp US dollar rallies, but a clear deterioration in Fed rate forecasts has similarly detrimental implications for the US dollar. As of Friday, interest rate traders predicted that the Federal Reserve would raise interest rates by a cumulative 28 basis points within 12 months, but markets are now pricing in effectively unchanged US dollar yields through most of 2009. Such dynamics bode poorly for the US dollar, but the greenback’s one saving grace is that interest rate expectations out of the euro and other major forex currencies are similarly bearish—making the dollar attractive by comparison.
Interest rate forecasts for the euro show that traders expect a cumulative 65 basis points in European Central Bank rate cuts in the coming 12 months, 111bp in cuts from the Bank of England, 134 basis points from the Reserve Bank of Australia, and a whopping 145bp from the Reserve Bank of New Zealand. Given such a backdrop, it seems that the US dollar’s yield advantage may actually improve through the medium term—giving us a somewhat bullish bias for the USD itself.