LONDON, Dec 15, Reuters - It's usually better for the dollar for the Fed to travel than arrive.
The sooner the U.S. Federal Reserve pulls the trigger on what would be the first of a new cycle of interest rate hikes, the more it will test the durability of the dollar's surprising strength.
One of the big macro market misses of 2021 was the shattered consensus that this would be a year of dollar depreciation where the Fed let the economy run hot, with no rate rises likely until 2023 at the earliest.
The dollar's DXY index is going to be more than 7% higher than a year ago, as few saw how overheated price rises would get and how irked the Fed would get by months of above-forecast inflation.
The overwhelmingly bullish dollar take on 2022 is at risk of being as wrong as the 2021 view in reverse because of the anti-consensus dollar surge this year has already priced the coming Fed cycle.
The world markets are on tenterhooks about Wednesday's final Fed policy decision of the year, assuming that inflation anxiety will double monthly tapering of bond buying and underscore market pricing for two rate rises next year - starting in June.
The bullish dollar show probably stays on the road with the outcome - according to most major forecasters, such as JPMorgan, Deutsche Bank and Goldman Sachs, along with easier settings from the European Central Bank and Bank of Japan this week.
What if the Fed said that the U.S. rate rises could begin as early as March, as some of the more hawkish forecasts suggest?
This is where it gets trickier.
One rule of thumb used to gauge dollar behaviour is that its broad index typically gains 4% over the 6 months before the Fed's liftoff.
Although it is not a crude averaging of different outcomes over time, it doesn't account for relative policy moves elsewhere and contains some exceptions, the broad assumption makes timing of the first Fed move super important for the buck.
If there's more than 6 months left to go, that's ready reckoner' points at considerably more strength. Is it just 3 months?
The Fed's broad dollar index has gained 4% since June, and that's exactly how much it's gained since June. The DXY index has gained as much as 6% against major traded currencies.
After the first hike, the dollar has done as important.
After rising before the Fed kicked off its first hike in 1994, the DXY index dropped about 15% even as rates were ratcheted higher through early 1995. The dollar rallied in tandem with the early hikes but turned tail 125 basis points below the June 2006 peak, and then fell more than 6% by the time the Fed tightened.
The dollar peaked just 3 rate rises into a 9 rate move - losing 10% at one point before the Fed declared it quits during the 2015 -- 2018 cycle.
Just like the surprise rollover of the U.S. Treasury yield curve in the second half of this year, it matters as much where the Fed is assumed to end its cycle as when it starts.
The money markets and yield curves are wrong and the dollar will continue to rise through 2022, which is why this is a puzzle.
Paul Meggyesi and the team at JPMorgan talked about this before the Fed decision this week and pointed out that the market has moved forward its liftoff date for some time this year while cutting the 'terminal rate' where it sees it ending.
This flattening in the policy curve and broader yield curve reflects a pessimism not only about the economy's cyclical resilience to a relatively modest tightening in policy but also the economy's growth potential and hence 'R-star', they wrote, referring to the so-called R interest rate that would theoretically exist if the economy was at equilibrium with stable inflation.
The JPM team rejected the money market 'pessimism'' that sees a terminal Fed rate of less than 1.75%, still well below the 2% end to 2024 indications from the median Fed policymaker 'dot plot' forecasts and the Fed's own assessment of a 2.5% 'neutral' rate.
In short, it reckons that the full Fed trajectory is not yet fully priced by the dollar and should continue to grind higher into lift-off What purchase in the money market the Fed might get from upping these 'dot plot' forecasts this week may reveal its credibility to some extent.
A mirror image of 2021 for the dollar is not fanciful - with the consensus of the new year prevailing early on only to flounder in the second half. That would lead to what Morgan Stanley calls an up-and-down year in which timing is key and policy divergence favoring the greenback is eventually replaced by convergence by 2023.