The argument is essentially this: the Fed reminds the market that more rate hikes are still in the cards (even if there isn’t one today), that leads to dollar strength, which in turn triggers a renewed downturn in commodities and thus a return to the same dynamics that waylaid markets earlier this year.
Here’s how Goldman put it last week:
While investors focus on oil and the ECB, they overlook the largest current macro market risk – and opportunity – which centers on the Fed. We forecast a tightening Fed and lower oil prices will return upward momentum to the performance of stocks with strong balance sheets.
And here’s Deutsche:
We think we are just one hawkish Fed statement away from a potentially sharp re-pricing of Fed tightening expectations, which would push up real bond yields (as happened after the start of the ECB’s QE program in Mar 2015) as well as the dollar. Any drop in commodity prices would risk putting renewed upside pressure on credit spreads.
Well, as we head into the Fed, Goldman’s Robin Brooks wants you to know that “the dollar rally is far from over,” thanks to a Fed that will be more hawkish than the market anticipates:
We expect the Fed to signal that it wants to continue normalizing policy, which means three hikes this year and four in 2017, with the statement referring to the risks as “nearly balanced,” reverting to phraseology used in October, just before December lift-off. Overall, our sense is that the outcome will be more hawkish than market pricing, in particular given that the FOMC may leave open the option of tightening at the April meeting.
And that means there’s as much USD upside now as there was 2 years ago, despite the rally since then:
Much as in April 2014, we can estimate the potential for Dollar upside if the 2-year rate differential moves in line with our forecasts for G10 policy rates. As Exhibit 2 shows, this implies that the 2-year differential could be between 120 bps and 150 bps higher than its current level, depending on whether we use the spot or 2-year forward differential. This translates into potential Dollar upside of between 10 percent and 15 percent, i.e., similar to the kind of estimates we had almost two years ago. It might seem puzzling that the potential for Dollar strength is largely unchanged, even though the Dollar has obviously appreciated a lot. Intuitively, this is because monetary policy normalization has really only begun, in addition to rates markets taking a very dovish view relative to our expectations for Fed tightening.
Or, in summary, Goldman doesn’t think the market knows what it’s talking about when it comes to what the FOMC is pondering in terms of the “flight path” for rates:
Implicitly, our estimates for Dollar strength are largely a reflection of the divergence between our Fed call and what markets are pricing. And there is admittedly a genuine tension there.