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Preview for March FOMC Rate Decision and Impact on US Dollar

Preview for March FOMC Rate Decision and Impact on US Dollar

Christopher Vecchio, CFA, Senior Strategist

Talking Points:

- Fed funds futures are pricing in a 100% chance of a rate hike today; that alone won't move the US Dollar significantly higher.

- Instead, the Fed will need to convince markets that interest rates will be moving higher and faster than previously anticipated - a tall task.

- Ahead of the FOMC decision, the retail crowd is net-short EUR/USD, net-long USD/JPY, and net-long GBP/USD - a mix that points to modest US Dollar weakness.

The March FOMC meeting seems merely procedural at this point. The Federal Reserve will hike its main rate to 0.75-1.00%, citing further improvement in the labor market (the latest NFP report showed the unemployment rate at 4.7%) and evidence that inflation has started to push through its medium-term target of +2%. The key for the US Dollar today, however, is to what degree of confidence the FOMC has in the US economy, or simply, 'how quickly does the Fed think it will be able to raise rates next?'

Whereas after the December FOMC meeting (the last one with a new Summary of Economic Projections (SEP) and a Yellen press conference), markets were pricing in rate hikes in June and December 2017. After the past few weeks of US economic data, markets have been quick to pricing in three rate hikes this year, with hikes being levied in March, June, and December 2017 (table 1 below).

Table 1: Fed Rate Hike Expectations Through December 2017

Preview for March FOMC Rate Decision and Impact on US Dollar

Given the high expectations going into today's meeting, the FOMC will need to take on a rather hawkish stance in order to see the US Dollar rally significantly further. EUR/USD itself may be currently predisposed for lower prices (and USD/JPY for higher prices given interest rate differentials), but the FOMC meeting will only yield such a result of the Fed rate hike expectations curve steepens – a difficult scenario to envision seeing as how markets have already moved quite far already.

We'll be keenly interested in hearing what Fed Chair Yellen thinks about potential changes in fiscal policy, which has been stagnant and an obstacle to growth for the past seven years. The feedback loop between fiscal stimulus and tighter monetary policy is fairly straightforward: the combination of reduced taxes and increased government spending will lead to deficits; deficits tend to push up inflationary pressures; and with inflation already at or above the Fed's +2% medium-term target, any policy that pushes up inflationary pressures even more will necessitate a faster pace of rate hikes.

Elsewhere, today marks an important day on the calendar for the US economy for another reason: the debt ceiling suspension that was put into effect in October 2015 expires today. While the US Treasury can maneuver around the issue for a short-while, a new compromise will need to be hashed out among Congressional leaders. Failure to do so in a quick and timely fashion, in context of the expected bump in deficit spending to come under the Trump administration, may put the idea of another US debt downgrade on the table at some point in the coming months; August 2011 is still very fresh in our minds.

Finally, a reminder that the FOMC is not the only central bank meeting this week. Currency Strategist James Stanley previewed the other two major events and their impact on FX markets, the Bank of Japan's and the Bank of England's March policy meetings, in a piece from Friday.

Read more: DXY Gains Ahead of FOMC; GBP Under ’Hard Brexit’ Pressure

--- Written by Christopher Vecchio, Senior Currency Strategist

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com

Follow him on Twitter at @CVecchioFX

To be added to Christopher’s e-mail distribution list, please fill out this form

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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