USD Coiling Before FOMC Holds, Hints at Hike Around June
- As FX market volatility stays elevated, it's a good time to review risk management principles.
The Federal Reserve will meet later today and will keep its main rate on hold around its 0.25%-0.50% target. This is widely expected, as markets have priced in less than a 10% chance of a hike today ahead of the meeting, and this has been the case since mid-February. This is almost universally understood. Instead, the divergence in views on what the Fed will do today results from varying levels of trust in the Fed's forward guidance. That's to say, no one can quite agree on what the Fed will actually do this year.
For the Fed, a meeting with a fresh round of economic projections and a press conference for Chair Janet Yellen offers a reset on what's been a rough start, communication-wise, for the Fed in 2016. The consternation drummed up in markets in Q1'16 was rooted in the Fed's ultra-hawkish outlook (relative to the other major central banks that constitute the IMF's SDR): that there would be around four rate hikes this year.
If the Fed doesn't hike today, but sticks to that outlook. that would mean it would have to hike four times over the last six meetings of the year - that's not happening as things stand. So, expect to see the Fed's 'dot plot' come in with a lower glide path, but not too much lower: a reasonable assessment would be for two to three rate hikes this year, with the commentary in the policy statement and press conference thereafter pointing to a rate hike on the table in the first half of this year still. The Fed's dual mandate is on track: the unemployment rate is at 4.9%, and while headline inflation is soft, core inflation is at +2.2% y/y and core PCE is at +1.5% y/y. From a Phillips curve perspective, this seems to be the 'growth sweetspot' the Fed looks for when it tightens policy.
While the Fed will say that April is a possibility, that seems like window dressing; during the fragile normalization process, the Fed will want to take every opportunity to explain why it's shifting policy at each turn in order to soothe market participants' fears. Out of caution, that means June (or September) become the next meetings at which the Fed will have the opportunity to hike. If the Fed's hiking at least twice this year, September would be bad timing with US elections around the corner; December seems more likely.
--- Written by Christopher Vecchio, Currency Strategist
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