The Federal Reserve is widely expected to raise interest rates by 25 bps in today’s meeting. Markets are fixated on whether the central forecasts of FOMC members will shift towards signalling 4 rate hikes this year from the current forecast of three rate hikes. Their views on growth and inflation will also be of relevance.
3 or 4?
Those who expect the dot plot to upgrade the median forecast to 4 Fed hikes from three point to the impact of the tax cuts as well as the recent positive economic data—soft data. That’s highly likely to push the growth forecast for this year above 2.5% this year and 2.1% in 2019.
But a close look at the Citi economic surprise index for the US indicates the index has fallen 50% from its January high, highlighting the increased data misses of the past 2 months.
We start with the pullback in February hourly earnings to 0.6% from January’s 0.9%, inflation remained unchanged at 1.7%, consumer prices index slipped on a month-to-month basis, while retail sales fell for the 3rd consecutive month– a pattern seen only three times over the past 7 years).
Against this backdrop, why would the Fed be in a hurry to signal more rate hikes?
Will Markets Buy it?
And in the event that that the Fed signals 4 hikes, would the US dollar be able to rise sustainably after the announcement? That depends on how much markets believe all four will be delivered. Right now, Fed funds futures pricing puts the chance at about 32%. When all said and done, I see the wages data and core PCE to remain as the commanding force behind markets’ expectations (fed funds futures and OIS curve) in affirming their stance for this year’s Fed hikes. So far, there is no reason to move from 3 rate hikes.
Fed chair Powell’s press conference–30 mins after the announcement — should help shape the market reaction to the dot plot forecasts in the way of his opening remarks as well his answers to the subsequent Q&A. It will be an opportunity for Powell to fine tune the message but Wednesday will be more about the potential for mistakes from a rookie central bank leader.
In the event that the FOMC dot plot upgrades its forecast to four rate hikes for the year, I see a high probability for growth forecasts as well as Powell’s speech & answers to lean in favour of a less hawkish stance. Conversely, I would expect a more hawkish/optimistic Powell delivery in the event that the dot plot sticks to three Fed hikes.
In sum, I caution against chasing USD longs on the ascent. Any USDX extension towards 90.90/91.00 is seen as a selling opportunity, while an immediate pullback will merit gradual selling.