Preview for December FOMC and Implications for US Dollar
- 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.
- Retail trader sentiment continues to suggest a mix trading environment for the US Dollar this week.
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The December FOMC meeting seems merely procedural at this point. The Federal Reserve will hike its main rate to 1.25-1.50%, citing further improvement in the labor market (the latest NFP report showed the unemployment rate at 4.1%) as the prime reason. Evidence that inflation has started steady and slip near the FOMC's medium-term target of +2% may prove to be troublesome for the greenback.
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?'
Before the September FOMC meeting (the last one with a new Summary of Economic Projections (SEP) and a Yellen press conference), markets were pricing in a 45% chance of a 25-bps rate hike in December 2017 and a 65% chance of another in June 2018.
After the September FOMC meeting, including the past few weeks of US economic data, markets have been quick to fully price-in a rate hike at the coming meet (Fed funds futures imply a 100% chance), but they have not moved on the timing of the next rate hike: June 2018 is still the next period in which Fed funds futures imply greater than a 60% chance of a rate hike at that meeting.
There is some dissonance going into today's meeting, given that the FOMC will need to defend its hawkish stance - it continues to call for three to four hikes in 2018 - in order to see the US Dollar rally significantly further. Given the prospect of a downgrade to the 2018 inflation forecast, it seems likely that a small downgrade to the Fed's 'dot plot' and thus the projected path of interest rates, the 'glide path,' will occur as well. Since the Fed's rate hike cycle started in December 2015, this pattern by the Fed of being 'hawkish up front, only to reduce tightening expectations on the backend' has proven to be detrimental to the US Dollar.
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.
We'll be keenly interested in hearing what Fed Chair Yellen thinks about potential changes in fiscal policy now that the US tax reform bill is close to making its way into law. At previous meetings with new forecasts, Fed officials have cautioned that they had not factored any degree of fiscal stimulus into their projections.
Should they choose to do so at this meeting, the feedback loop between fiscal stimulus and tighter monetary policy would be made apparent and perhaps offer US Dollar bulls something to work with: the combination of reduced taxes and increased government spending will lead to deficits; deficits tend to push up inflationary pressures; and with inflation already near the Fed's +2% medium-term target, any policy that pushes up inflationary pressures even more will necessitate a faster pace of rate hikes.
See the above video for for an archive of this morning's "Mid-Week Trading Q&A: FOMC Preview" webinar in which technical outlooks for the DXY Index, EUR/USD, GBP/USD, USD/JPY, AUD/USD, USD/CHF, Gold, and US yields were reviewed.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
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