Key quotes from the Goldman Sachs (NYSE:GS) report:
Long USD into the FOMC
If we are right and the Fed again uses this meeting to lead the market toward the next rate hike, this should be dollar positive. Taking the October meeting as a template, from the day before to the day after the FOMC meeting, the 2-year USD rate increased 9bp from 0.53% to 0.62%, the probability of a December hike moved from 35% to 50% and the USD appreciated 0.4% against the G-10 currencies. This trend continued uninterrupted until November 9, when the 2-year USD peaked at 0.79% and the probability of a December hike rose to 80%. Over this period, the USD appreciated 1.70% vis-à-vis the G-10 currencies, EUR/$ moved from 1.1045 to 1.075 (a 2.74% EUR depreciation) and $/yen moved from 120.46 to 123.18 (a 2.26% yen depreciation). Shorts NZ dollar offered the highest return at around 2.74%.
This outcome probably overstates EUR/$ downside, since the October meeting was just after the dovish Oct. 22 ECB meeting, when the market was still repricing EUR lower. The odds of that happening again on the same scale – following two disappointments for the FX market from the ECB – are obviously lower, which is making us more cautious on EUR/$ downside tactically.
Currency sensitivity to USD rate changes
To isolate by how much such moves in the USD G10 crosses were driven by a repricing of USD rates (due to a repricing of the Fed’s cycle or US data) versus other factors, we focus on EUR/$, $/JPY and GBP/USD and expand our rate differential model by estimating the coefficients on the daily change of the 2-year swap rates separately. We also let the 2-year USD rate coefficient vary over time to check whether after the October FOMC meeting exchange rates’ sensitivity to changes in the 2-year USD swap rate has changed. The results from our model are quite close to those implied by the simple descriptive statistics discussed above: a 30bp move in the 2-year USD swap rate is associated with depreciation of the EUR, yen and GBP of about 3.2%, 2.3% and 2% respectively, all else equal.
Furthermore, while we find evidence that since the beginning of the year the sensitivity of the EUR/$ and GBP/USD to changes in the 2- year USD rate has declined somewhat, the current coefficient would still imply that a change in the 2-year USD swap rate similar to that observed in the aftermath of the October meeting would (all else equal) move the EUR/$ down by 3 big figures (from 1.11 to 1.08), $/JPY higher from 113.68 to 116.4 and the GBP/$ down from 1.43 to 1.408.