Potential for ECB Surprise Boosts Euro’s Appeal

The euro is in demand.

Photographer: Bloomberg

It's about to get a lot more interesting for the dollar and the euro, with both the Federal Reserve and European Central Bank scheduled to meet next week. Expectations are high that the Fed will raise interest rates for the third time this year, while the ECB will keep its main rate at zero, where it's been since early 2016. But that doesn't mean the dollar is poised to outperform as the euro lags behind.

The dollar has had a tough year, mostly weakening since the end of 2016 before briefly rebounding in September and October. Now, it's back under pressure as the reality of additional deficit spending as a condition sine qua non for tax cuts becomes evident. The technical trading picture doesn't look good for the dollar either, even if Fed policy is likely to be more aggressive in 2018 than it was in 2017.

We have been expecting the Fed to boost rates in December since July. Traders put the odds of a rate hike next week at almost 100 percent, according to data compiled by Bloomberg. And make no mistake — with the near complete implementation of tax cuts, more Fed rate increases are coming. Next week, the U.S. central bank will also provide updated forecasts for economic growth and interest rates, and those are likely to reflect the potential for more aggressive policy action in 2018 and 2019 than was forecast in September. That is likely to give the dollar a jolt even if the Fed hikes rates by only 25 basis points, as expected.