Market Attention Shifts to Yen, BOJ as US Dollar Eases Post-FOMC
- Fed funds still pricing in June 2017 as most likely period for first hike.
- Bar for BOJ action is high, which means propensity for disappointment is too.
- FX volatility set to remain high - it's the right time to review risk management principles to protect your capital.
At first blush, the Federal Reserve's policy statement yesterday, despite there being no change in rates as expected, was a touch more hawkish than anticipated. Optimism over recent improvement in the labor market and relaxation of concerns over foreign market developments (cough cough, Brexit) highlighted a Fed that is backing away from its pseudo-crisis posturing and instead flipping back into the data dependency mode.
While these slight changes to the FOMC's outlook, coupled with the fact that there was a dissenter calling for a rate hike, leads us to believe that there was more than a spirited debate at the FOMC meeting. Indeed, in three weeks' time when the July FOMC minutes are released, there should be signs that several policymakers are closer to calling for an outright hike, if not for overriding caution for exogenous risks. Therefore, in September, we;ll be looking for the Fed to reinsert language into its policy statement that it is preparing to hike at one of the forthcoming meetings - akin to the 'hawkish holds' we saw in September and October 2015.
While the undercurrents of the FOMC are nuanced and likely indecipherable to most market participants in the near-term (hence the US Dollar pullback), there is one place to look that highlights the stability of the market's pricing around the FOMC (and therefore the major reason not to look for significant US Dollar weakness just yet): rate expectations.
Fed funds implied probabilities barely moved over the past 24-hours, with today seeing only a -4% less chance of a hike in December 2016 compared to yesterday, and likewise, only a -4% less chance of a hike in June 2017. This is not a material shift lower in expectations by any means.
Accordingly, it seems that the minor US Dollar weakness resulting from yesterday's FOMC meeting are simply weak hands being shaken out (there was a 12% chance of a hike yesterday pre-FOMC - some market participants were very wrong and had to reverse their positions in all likelihood, contributing to the minor pullback).
Until interest rate expectations fall back materially, there is little reason to believe that the US Dollar is beginning its next leg lower at present time.
--- Written by Christopher Vecchio, Currency Strategist
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