Momentum trades are in vogue. This week will be about whether a dovish FOMC reinforces the USD bear trend, while the BoE-fuelled GBP rally faces a pivotal test from PM May’s keynote Brexit speech.

Theme of the week: Will a dovish Fed reinforce the USD bear trend?

The Sep FOMC meeting will be the main event of the week (Wed), with investors looking to see if there is any change in policy bias in light of the recent negative developments in the US economy. We think this may be one of the more difficult meetings and press conferences for Chair Yellen to navigate, not least because of the growing dichotomy within the FOMC over the appropriate near-term policy approach. Our base case is for the doves to prevail, with a lower conviction over the pace and extent of future policy tightening visible in the Fed’s dot plot. While the median 2017 dot is still set to tentatively pencil in a Dec rate hike, we expect to see more members calling for a pause for the remainder of the year; anything more than five would suggest that hopes of a Dec hike stand on a fragile footing. More telling of a dovish shift would be if the 2018 dot also moves lower; here we require five or more members to downgrade their views over future policy hikes, a scenario that cannot be ruled out given the softer US inflation dynamics. What is highly likely is that we’ll see the 2019 and longer-run dots moving lower – with Fed officials acknowledging that a 2% handle for the terminal Fed funds rate is more realistic in the prevailing US economic environment.
While we do not expect US yields or the USD to move much on what would be a well-telegraphed balance sheet announcement this week, there is a slight risk of the Fed delaying the start of this process. This would be indicative of the Fed’s more pessimistic view of the US economy and we would expect this tail risk scenario to be outright USD negative – more so through the sentiment channel, rather than any major move lower in US yields.

Majors: Dovish Fed to trump cautious ECB & BoE
While a dovish FOMC could reinforce the USD bear trend, ECB officials will look to keep their QE taper cards close to their chest this week. The BoE-fuelled GBP rally faces a big test from PM May’s keynote Brexit speech in Florence on Friday.

EUR: Dovish Fed confirmation could see a 1.20 handle again
• The September FOMC meeting is the main focus this week (Wednesday) and we will be looking to see how Chair Yellen manages the two emerging camps within the committee – that is those members looking for a continuation of the current normalisation cycle and those looking for an extended (or even permanent) pause in hikes until there is greater confidence in the US inflation outlook. We note that it’s typically hard for the dollar to rally post-FOMC meetings and this time may not be any different; any hawkish Fed cries could again fall on deaf ears given the lack of convincing economic evidence to point to. Moreover, we do not expect to see US yields or the USD moving much on what would be a well-telegraphed balance sheet announcement this week – especially as offsetting this will be a downshift in the distribution of Fed dots and signs of less conviction from the committee over the pace and extent of future monetary tightening.

• While Fed officials will also follow up the meeting with their own views (Williams, George and Kaplan all on Friday), the focus in the European calendar will be on ECB talk – including two speeches by President Draghi (Thursday and Friday). We would expect much of the same script as the September ECB meeting, with Mr. Draghi likely to keep his QE taper cards close to his chest. Our economists also expect no change in the final release of EZ CPI data (Monday).