Currency strength could rein in the Fed hawks

The US has seen a substantial impact from USD strength in recent years. Despite being less open than other developed economies, US GDP growth has been impacted by lower net exports while inflation pressures have been subdued. Unless there is a notable acceleration in US price pressures in the coming months, the Federal Reserve may be forced to further rein in hawkish rhetoric to tame upside potential for the USD. 

Since July 2014, the broad real US effective exchange rate has risen by around 15%. Fed Vice-Chair Fischer recently put in perspective the impact of USD strength by referring to Fed staff estimates which suggest that a 10% dollar appreciation would reduce US GDP by 1-1/2% via net export channels after three years. Staff also estimate that a 10% rise in the USD may depress core PCE inflation by about 0.5% in two quarters. 

Fischer also clarified that "the stronger dollar and some of the factors causing it, including weaker foreign demand, have played an important role in accounting for revisions to the expected path of U.S. policy rates compared with what was expected in the summer of last year". In short the stronger the USD, the more gradual the pace of Fed policy tightening is likely to be.