Goldman Sachs sticks to call for three 2016 Fed rate hikes, calls ECB action "misfire"

The 'dovish' shift in the US central bank´s policy stance after its 15-16 March meeting was a "surprise", but it would only temporarily arrest strength in the dollar, Goldman Sachs said.

Indeed, volatility in the Fed´s messages since last September "argues against taking this latest surprise too seriously. If we are right about data, the Fed could quickly reverse course, in line with our US team’s call," Robin Brooks, Silvia Ardagna and Michael Cahill said in a research note sent to clients and dated 20 March.

Economists at Goldman Sachs continued to expect three interest rate hikes from the US Federal Reserve in 2016, which they estimated might drive the US dollar another 15% higher.

In their report, the analysts emphasised three points:

1. Dovish shifts from the Fed over the past year had only been able to put the Dollar into a holding pattern, they had not reversed the 2014 rise;

2. Data would ultimately force the Fed’s hand, which is why its US economists had stuck with their call for three hikes this year;

3. The underlying case for the divergence trade was stronger, not weaker, given that a dovish Fed would spur US outperformance versus the Eurozone and Japan.

The growth and inflation picture Stateside continued to look robust despite the large appreciation seen in the Greenback´s value in the second half of 2014, the broker said, which meant the underlying momentum in the American economy was "stronger than it appears".

Brooks, Ardagna and Cahill backed up their arguments by pointing to the recent "material" easing in US financial conditions, driven by a rebound in stock prices and tighter financial conditions as well as weakness in the dollar versus other G-10 currencies and those of emerging markets.

A more dovish Fed would only drive further 'divergence' or outperformance by the US against the Eurozone and Japan, the broker argued.

Furthermore, that easing in financial conditions had come at the expense of its G-10 peers Goldman said, which "makes no sense" - with the situation having been compounded by the European Central Bank´s pivot towards credit easing.

As regards the recent moves by several of the world´s main central banks which coincided in a short space of time, Goldman gave short shrift to talk in markets of an agreement between the ECB and Bank of Japan not to pursue polices that might lead the dollar to appreciate.

"We see no conspiracy to stabilize exchange rates, just an unfortunate string of misfires from central banks (most notably the ECB), which will ultimately reinforce the divergence theme."