Onto the Fed

Dec 12 2017, 5:45 pm

Wednesday’s Federal Reserve announcement on interest rates (2 pm New York, 7 pm London, 11 pm Dubai) is widely expected to produce a 25-bp rate hike in the Fed funds rate range to 1.25-1.50%. Traders will look out for these two crucial aspects in the announcement:

The number of rate hikes projected for 2018

  • The number of interest rate hikes signalled for 2018 by the FOMC members’ Summary of Economic Projections, known as the dot plot. The market anticipates this number to be three rate hikes, leading the Fed funds target range to around 2.75% at end of 2018. I see as much as a 60% chance of these forecasts producing a surprise, implying four rate hikes to occur by end of 2018, rather than the expected three hikes expected.

It is worth mentioning that it does not matter to the market that in 2015, 2016 and 2017, the Fed ended up delivering fewer rate hikes than it had forecasted at the end of each preceding year. What matters instead is any deviation above expectations and the resulting market reaction. Traders usually react first and ask questions later. Thus, if 4 hikes are implied, then we should see a swift bounce in the US dollar, US bond yields and rapid sell-off in metals. Whether such reaction would prolong until end of week or the following is not certain.

Growth and inflation outlook

  • The other aspect, is the forecasts for inflation (core PCE) and GDP growth. Will these be revised upwards or downwards from the September projections? They will come in two forms: numerically in the actual forecasts of the dot plot forecasts; and qualitatively in the FOMC statement.

The main question when reading the Fed statement and listening to Fed chair Yellen’s press conference is whether the central bank will continue describing readings of low inflation as transitory. The most likely answer is “yes”, in which case, should help support the US dollar.

USD Reaction

FOMC

It is one thing to anticipate a knee-jerk reaction in the dollar on such scenarios, but the continuity factor is another matter. We saw this time last year how USD optimism soared on the notion that: 1) Trump’s planned infrastructure spending would boost yields and inflation expectations; 2) Trump’s border adjustment tax would limit imports and favouring the greenback and; 3) The US will grow in a vacuum.

None of these materialized. Populism was and will never be positive for the currency. The Eurozone grew firmly, pushing the ECB to curtail the size of QE. Will this time be different? Maybe. Energy prices are up 20% since the same time last year, which could help inflation higher. But once again, higher inflation expectations are not exclusive to the US or the Fed as we have seen from this year’s moves in the ECB, BoC and BoE. The week’s volatility could well drive the USD index near 94.00, but a definite break above 94.50 or a close under 1.1560 in EURUSD remains highly unlikely.

(Visited 483 times, 6 visits today)