US Dollar May Fall Even as Fed Delivers Interest Rate Hike

Talking Points:

• US Dollar pulled back overnight ahead of Fed rate decision
• FOMC forecasts and commentary likely to stick to status quo
• Announcement passing may set off unwind of long-USD bets

The US Dollar underperformed in overnight trade, pulling back from a perch near 13-year highs. The move probably reflected investors scaling back exposure ahead of the upcoming Federal Reserve monetary policy announcement. The rate-setting FOMC committee is widely expected to issue the year’s first and only increase in the target Fed Funds rate.

The hike has been widely expected, with futures markets implying the priced-in probability of tightening at 100 percent for some time. That seems to imbue post-announcement comments from Fed Chair Yellen as well as updated policy and economic forecasts with market-moving potential. Here too however, straying far from the status quo seems unlikely.

Central bank officials are probably looking to avoid a communication misstep like the one they made exactly 12 months ago, when they projected four rate hikes for 2016 while traders had priced in just two. The markets balked, triggering a violent deterioration in sentiment and committing the Fed to a clean-up effort that occupied most of the subsequent year.

With this in mind, the FOMC will likely do its utmost to avoid rocking the boat. Yellen is well-practiced in seemingly meaningful but ultimately vague and non-committal rhetoric. Further, much of the Fed top brass has signaled that next year’s outlook is highly contingent on the direction of fiscal policy following the election of Donald Trump, so there is little impetus to change September’s economic and rate path forecasts.

On balance, this means the rate decision may offer little to propel speculation. In this case, markets could treat it less like an inflection point and more like the passing of the last bit of top tier event risk for the year. That may open the door for the onset of profit-taking as investors square their books ahead of the calendar turn to 2017. In the context of recent moves, this may send the greenback lower even as rates rise.

UK jobless claims data headlines the economic calendar in European hours. A rise of 6.5k in applications for unemployment benefits is expected. This would be broadly in line with the near-term trend average and seems unlikely to push the BOE out of wait-and-see mode. That means the result will probably not offer a strong lead for the British Pound.

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--- Written by Ilya Spivak, Currency Strategist for DailyFX.com

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