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Talking Points:

- This afternoon sees the release of FOMC minutes from the most recent meeting in July; and in July, the bank took a slightly more-hawkish stance yet markets continued to expect dovishness. Will the release of minutes from this meeting re-fire USD strength on the back of a more hawkish Fed (such as what we saw in April/May).

- Over the past two days we’ve heard from two different Fed members talking up the prospect of a hike in September. This is, again, very similar to what we saw in May as the Fed tried to transmit a more-hawkish stance to markets.

- This isn’t to say we’re expecting any actual hikes anytime soon, but FOMC expectations have become a primary driver in markets, so traders need to try to ‘expect’ the ‘expectation’ of the Federal Reserve.

- If you’re looking for trading ideas, check out our Trading Guides. And if you want something more short-term in nature, check out our SSI indicator. If you’re looking for an even shorter-term indicator, check out our recently-unveiled GSI indicator.

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Meeting Minutes from the July FOMC meeting are set to be released today at 2 PM ET, and given some of the recent Fed commentary, the delivery of these minutes are lining up to be very interesting. At issue are market expectations around near-term FOMC monetary policy, and this has been a saga that’s deepened in front of our very eyes over the past year.

Throughout last summer, the Fed continued to talk up the prospect of a hike in September (2015). But just about a year ago Chinese capital markets began to crater, and when the PBOC responded by massively weakening the Yuan in a ‘revaluation’ of the Dollar-Yuan peg, global markets ducked for cover for fear of economic contagion. This caused the Fed to back off of those rate hike plans for September, but when the bank tipped that they’d still be looking to hike rates in December. When the bank did finally hike in December, they also accompanied that move with the expectation to hike rates a full four times in 2016.

And for a global economy that struggled for much of the year just to see one rate hike out of the Fed, when this expectation for four hikes was combined with the slowdown in Asia and the carnage in commodity prices, the palette of risk was too much for global markets to bear, and within hours of the open of the first trading day of the new year risk aversion had begun to boil again. And this lasted all the way until Chair Yellen’s Humphrey Hawkins testimony in February, when, in front of Congress, the head of the Fed implied that the bank could employ even more tools (potentially negative rates) in the effort of bringing on inflationary pressure. This was largely inferred as a dovish move from the Fed, as a bank investigating cutting rates into negative territory probably isn’t going to be hiking anytime soon.

The chart below shows the up-trend in the Dollar that lasted through much of the second half of 2015 (in green) turning into a down-trend around the Fed’s swap towards a dovish stance at the beginning of the year (in red).

FOMC Rate-Hike Expectations: The Saga is Set to Continue

Created with Marketscope/Trading Station II; prepared by James Stanley

This was confirmed at the March FOMC meeting when the bank cut their expectation to two rate hikes for the remainder of the year from the previous four, and this ‘less hawkish’ read from the Fed did pretty much the same thing that a ‘more dovish’ read would’ve done, which is propel stock prices further while the US Dollar continued to sell-off.

April, however, brought a change of tune from the Fed. After market expectations for rate hikes in 2016 continued to sink after the March FOMC meeting, the bank said that they felt markets were underpricing the probability of a hike at their next meeting in June. Markets, in their pragmatic drive, had come to expect the Fed to continue their pattern of passiveness towards rate hike policy while global risks continued to flag. But the bank didn’t see matters that way, and in the statement from the April Fed meeting the bank posed a ‘less dovish’ stance by removing a key phrase from the previous statement in March; implying that global pressures would preclude the bank from posing any near-term rate hikes. When this phrase was missing from the April statement, this implied a more hawkish stance from the Fed, but markets didn’t seem to incorporate this more hawkish stance until the release of the meeting minutes from April, at which point the US Dollar continued to rally higher (shown below in the blue box).

FOMC Rate-Hike Expectations: The Saga is Set to Continue

Created with Marketscope/Trading Station II; prepared by James Stanley

But in early June, markets got a rude awakening with a shockingly bad NFP report. This near-immediately brought a dent in USD price action, and this weakness continued throughout June until we got to the Brexit referendum, at which point a rush of demand came into the Greenback driven by risk aversion from Europe.

And that strength lasted all the way through the July FOMC meeting, at which point, again, the Fed made a slightly-hawkish modification to their statement; this time including the phrase ‘near-term risks to the economic outlook have diminished.’ This is very similar to April when the Fed made a slightly-hawkish modification to the statement at a non-press conference meeting, and just like we saw in April markets weren’t ‘buying’ that idea. Two days later, we got an abysmal GDP report out of the United States and just like we saw in early June, market players further priced-out the probability of a hike in the near-term (shown in the red box below).

FOMC Rate-Hike Expectations: The Saga is Set to Continue

Created with Marketscope/Trading Station II; prepared by James Stanley

Over the last day-and-a-half, we’ve heard from two different Fed members taking on a hawkish stance towards future policy. Mr. William Dudley gave comments yesterday that alluded to the bank’s ability to pose a hike in September, far earlier than what markets were expecting. And then Mr. Dennis Lockhart gave comments that indicated that two rate hikes might be possible this year, with a strong eye on September. Since those commentaries have come-in to the market, the US Dollar has been rallying as we move nearer to the release of Fed minutes from the July meeting.

FOMC Rate-Hike Expectations: The Saga is Set to Continue

Created with Marketscope/Trading Station II; prepared by James Stanley

The big question as we go into this afternoon’s data is whether or not we’re going to see a redux of the April/May FOMC pivot, when market expectations were extremely dovish and the Fed prodded the US Dollar higher by transmitting a more hawkish-stance.

--- Written by James Stanley, Analyst for DailyFX.com

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