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Dollar Faces a Skewed Fed Response, Dow Rallies with Reckless Abandon

Dollar Faces a Skewed Fed Response, Dow Rallies with Reckless Abandon

2016-12-14 05:06:00
John Kicklighter, Chief Strategist
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Talking Points:

  • The Dow Jones Industrial Average and S&P 500 extended their incredible bull run with seeming little regard for the FOMC decision ahead
  • Markets pricing in certainty of a Fed hike today makes for a significant skew on potential market reactions to different outcomes
  • It is important to look beyond the central bank rate decision to long-term trends, liquidity and event risk (like Aussie jobs, the BoE decision and more)

Sign up for the live FOMC rate decision coverage Wednesday and see what other live coverage is scheduled to cover key event risk for the FX and capital markets on the DailyFX Webinar Calendar.

'Twas the night before the Fed, when all through the house; not a creature was stirring...except US equities. We are heading into the most important monetary policy event for the global markets since the US central bank announced lift off after years of ever-expanding stimulus 12 months ago. The relationship between risk appetite and extreme central bank support has become common place over years of persistence expansion. Yet, on the eve of another cut in the access to easy money, the champion of speculative appetite - US stock indexes - extended the climb to record highs without even breaking stride. The Dow is now running a seven-day consecutive rally and the S&P 500 is more than two-standard deviations above its 20-day moving average. This would insinuate it is fully priced in, but it would also suggest it matters little to investor sentiment. Yet there are many shortcomings to the current speculative run, and this eases none of them.

While speculative preoccupation is remarkable, the Dollar's reflection of the impending event risk is following the normal course of this important event. In hours and day preceding its catalization, the Greenback has clearly stalled in its bull trend. Yet, the proximity for the ICE Dollar Index to 13-year highs reflects well the remarkable speculation surrounding the outcome. Through Fed Funds futures, the market is pricing in a 100 percent probability that the central bank will decide to hike. That would further distance the US currency and assets from its global counterparts by promising a slightly higher yield that can nevertheless send a cascade of capital directed to any yield or taking advantage of the momentum that can build behind these flows. The intensity of speculation and run for the currency however has set expectations very high. It is therefore more likely that this event disappoints to some degree even if the move is technically to tighten.

For traders and investors, it is important to remember that this volatility event is fleeting. While the Fed decision can create significant volatility with considerable risk and opportunity, there are other fundamental and technical currents that will provide setups after it passes. After the FOMC announcement, we will immediately face rate decisions from the UK, Swiss and Norwegian central banks; Australian employment statistics; and European PMIs among other scheduled events. This is not to mean that we should pay only 10 minutes attention to the Fed reaction and move on. It will likely have profound impact on activity levels, global monetary policy influence, growth and more going through December and into 2017. That said, it is important to account for the speculative leverage, liquidity conditions and fundamental crosswinds that will shape the trading environment. We discuss the tumultuous period ahead in today's Trading Video.

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