Talking Points:
- With the US polls settled, the markets will refocus on more consistent fundamental themes: like monetary policy
- The FOMC rate decision is not expected to result in a change in rates at this meeting, but markets are particularly sensitive
- There is considerable asymmetry to this event with little scope for a hawkish surprise but much to lose on a dovish one
The Difference in Potential Between Elections and a Fed Decision
The US midterm elections were an overwhelming force for the global markets. The single country's trip to the polls drew international interest as the country has made itself the focal point of so many important changes in the financial and economic tapestries. Yet, as far as the United States' influence may stretch, the actual change in trajectory that will follow the government shake up is likely rather small for the world's markets. Sure, the shift in potential for programs like a second tax reform and infrastructure spending, the use of the currency as an unquestioned reserve and the long-term credit rating of its sovereign debt hold extraordinary influence. However, these are issues that will take months and additional fundamental contribution along the way to fully realize. Contrast this important fundamental spectrum to the influence of the Federal Reserve's monetary policy bearings. The Federal Open Market Committee (FOMC) will draw its delayed (by the election) two-day meeting to a close Thursday and deliver its policy decision. The market is confident in the otucome with only a 13 percent chance of a hike at this month's gathering. That said, there is near certainty of a hike at the subsequent central bank decision in December. It is that outlook which will guide the Dollar's and risk's performance.
A Skew in Outcomes and a Skew in Market Response
Though the 13 percent chance of a hike for today's meeting is not total conviction for a hold, nor is the 78 percent chance of a hike at next month's meeting certainty of a hike, these are clear majority presumptions. Such anticipation sets market pricing above and beyond mere anticipation. If there is a hold at the close of the event, there will be no material change to work with. Even if the Fed were to offer absolute confidence of its fourth hike in 2018 come December, this would still be confirmation of the status quo. There may still be a reaction from such an outcome. There is some very moderate discount for that view and the context of a more difficult economic and politial environment may register such persistence as additional strength. Alternatively, any sign of a dovish view would certainly alter the tempo of speculation in the market. Any doubt that is cast over a fourth hike in December will be met with a need to drain some excess premium for the Greenback. The need to pull back from policy normalization can also take its toll on risk trends. If the Fed is no longer confident in the environment such that it can pursue such an explicit - and supposedly gradual - pace of rebalance, then concern over growth and financial health will start to arise. If anything, this event has far greater potential to represent a burden rather than a boon to the Greenback.
The Risk Take and Dollar Counterparts
While the Dollar's take on the central bank rate decision is undoubtedly the most direct, we should not underestimate the implications for risk trends. Not long ago, a rate hike was considered a sure fire way to touch off a panic amongst speculators as the extreme accommodation was considered crucial to sentiment. That concern still resides with most of the major central banks around the world, but a clear exception remains for the Federal Reserve. If this uniquely aggressive pace of tightening were to slow, it could speak to a failed exit at escape velocity which could in turn add momentum to risk averison and overhwelm markets at a time where there is little capacity by the world's major central banks to do anything about a future crisis. For the Dollar, the skew in potential in monetary policy represents a clear and consistent burden for bulls. Add to that reasonable uncertainties of trade war blow back and a retreat in reserve appeal, and the pressure for a genuine bear trend is troubling. Of course, where we look to take advantage of this disparity in perspective is just as important as the underlying concept itself. If we are looking to escape the Dollar with a mind towards liquidity, EURUSD is the present champion. Of course, with the Euro's Italian concerns, the Japanese Yen may give the EUR a run for its money on top alternative. If the Dollar weakenes without risk trends taking a hit, I still believe AUDUSD and NZDUSD are the best options to consider. We focus on the upcoming FOMC rate decision in today's Quick Take Video.
