David Forrester, the bank’s FX strategist told CNBC Monday that markets have been predominantly focused on U.S. inflation data and pricing in an overly cautious Federal Reserve. But, he thinks the Fed will be more hawkish than what is currently expected, which will support the U.S. dollar.
“The Fed seems to have changed its policy response function. Yes it’s going to pay attention to the data, but less so. It now wants to get its rates normalized so that it actually has room to cut rates in the next downturn,” Forrester said.
“Let’s not forget here: The U.S. expansion, while being soft, is actually pretty mature so the Fed is getting lined up here in preparation for the next downturn. That’s why we think they’re going to hike rates and we will see a steepening of the U.S. Treasury curve and that will be supportive of the U.S. going forward.”
Credit Agricole expects the Fed to hike rates once more this year, followed by three times in 2018. U.S. inflation — still below its 2 percent target despite a low unemployment rate — has been a key point in the argument on whether the Fed should continue normalizing rates.
Forrester said the divergence between the unemployment rate and inflation is not unique to the U.S. Globally, economies face structural issues such as ageing populations and automation replacing jobs, which could increase the risks of a recession.
But, he said U.S. inflation should pick up on the back of further wage growth and a rebound in oil prices.
“We expect the U.S. economy to continue to recover and strengthen, we will believe in the Philips curve in the U.S. We do expect wages growth to accelerate and inflation expectation(s) to pick back up. So all-in-all, we do expect that re-steepening,” he said. The Philips curve relates to a supposed inverse relationship between the level of unemployment and the inflation rate.