- Rates markets are still pricing in a 25-bps rate hike today, although some market observers are now calling for a "hawkish hold" - no change in policy, but clear intention to hike again soon.
- Ongoing weakness in energy prices is weighing down inflation expectations, giving the Fed good reason to reassess its hike cycle.
- Retail traders have started to build into more bullish US Dollar positions.
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The US Dollar (via the DXY Index) has spent the early part of the week playing ping pong between support and resistance of a six-week long symmetrical triangle - a clear sign of indecision among traders during the run-up to the December FOMC meeting, the last this year.
What to Expect from the FOMC Today
After speeches by Fed Vice Chair Richard Clarida and Chair Jerome Powell in early-December, as well as the release of the November FOMC meeting minutes, expectations have started to build that the FOMC will slow down its pace of rate hikes moving forward. A wide gap has emerged between the Fed's plans and market pricing.
As such, attention today will be on the updated Summary of Economic Projections, where it seems very likely that: (1) 2018 and 2019 growth forecasts could be downgraded, in part due to growing trade war concerns; (2) 2018 and 2019 inflation forecasts could be downgraded, largely due to movement in the US Dollar and energy markets (Crude Oil was down another -13% this week, coming into today); and finally (3) the glide path for future rate hikes is reassessed, suggesting a slightly slower pace moving forward.
Rate Hike Path Needs to be Addressed
At the September FOMC meeting, policymakers outlined a path of one more 25-bps hike in 2018, three hikes in 2019, and one hike in 2020. However, ahead of the December policy meeting, rates markets are pricing in one more 25-bps hike in 2018, one hike in 2019, and a rate cut in 2020. According to Fed fund futures pricing, odds for a 25-bps rate hike today have come down from 81% in mid-November to 67% today. These changes in pricing give today's meeting a 'dovish' hue, even if a rate hike is levied.
For the US Dollar to rally, the Fed will need to prove resilient to recent developments, thereby suggesting markets are underpricing the risk of future hikes. This seems highly unlikely given the exogenous risks abound (energy prices, US-China trade war, Brexit, etc.). Otherwise, the base case scenario of a ‘dovish hike’ doesn’t seem ready to help the US Dollar reach escape velocity from its symmetrical triangle.
DXY Index Price Chart: Daily Timeframe (June to December 2018) (Chart 1)
The symmetrical triangle building over the past six-weeks may finally see a breakout tested around the FOMC meeting today. It's important to approach the symmetrical triangle with an open mind for outcomes in either direction (despite our fundamental leanings). For bulls, a bullish breakout would be validated above the November 28 bearish outside engulfing bar at 97.54. For bears, the validation level comes in below 96.36, below the December 10 bullish outside engulfing bar's low came and daily 50-EMA.
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
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