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Fed Rate Decision Will Swamp Headlines but Dollar's Motivations Lie Elsewhere

Fed Rate Decision Will Swamp Headlines but Dollar's Motivations Lie Elsewhere

2018-08-01 03:39:00
John Kicklighter, Chief Currency Strategist

Talking Points:

  • The FOMC is due to weigh rates Wednesday at 18:00 GMT, though this is not a quarterly event with an updated SEP
  • According to swaps, the chance of a rate hike is less than 2%; but the forecast for two more hikes in 2018 is 65%
  • Rate expectations are well-established due to forward guidance, so what what is most important in dictating Dollar trend?

Are you trading the Dollar or keeping track of monetary policy's influence on broader sentiment trends? If so, join me for live coverage of the FOMC rate decision starting 15 minutes before the official announcement. Sign up on the DailyFX Webinar Calendar.

What Is and Is Not Likely from the FOMC Rate Decision

There is little doubt that the Federal Reserve's monetary policy deliberations command attention from global investors. The world's largest central bank also happens to be one of the most hawkish developed world policy authorities. That confers considerable value to the US dollar, but it is also a considerable liability for risk trends both for markets both local and global given the pull this bank has for the world's financial system. As weighty as this central bank's decisions are, though, the probability that it is readying for a serious shock to the system at Wednesday's meeting is set remarkably low. In fact, according to overnight swaps, the probability that the Fed Chairman Powell and crew raise its benchmark lending rate so soon after June's hike is less than 2 percent. That is the power of forward guidance - it is just a hair more restrained than certainty. That said, each meeting stirs market interest effectively enough. If this is not a 'hot' meeting, it will cater to highly-attuned speculative market that knows forecasts can be shaped in the subtle rhetoric that anchors the statement. Another important point of context to this meeting is President Trump's recent pressure. He voiced criticism over the Fed's tightening policy suggesting it put the country at a disadvantage while simultaneously remarking that the Euro and Yuan were being actively devalued.

FOMC Rate Decision Scenario Table

Monetary Policy Still Matters Even if Volatility Isn't Charged

The probability of a surprise monetary policy update from the Federal Reserve is very low. That is in large part because the group recognizes that stoking volatility would only hurt the central bank's own interests in preventing unnecessary financial market volatility (likely because they recognize the economic fallout it can prompt). That said, there is still remarkable influence in this central bank's efforts and in global monetary policy in general. For US policy itself, there are appearances to keep up. The Fed is by far the most hawkish major group in the developed world, but it is extremely unlikely that it will be able to further that advantage. Already moving at a presumed four-hikes-a-year pace puts the central bank at an extreme contrast to its counterparts. To accelerate further would be to take the trains off the tracks and spur that volatility they are looking to avoid. Further, an overly aggressive US central bank could raise anticipation of a global shift in monetary policy to the point where the market recognizes how dependent capital markets were on exceptional easing during the previous boom years. Anything that reminds us that this is a temporary support and that the speculative rank was way too indulgent at the height of its reach, the more painful the day of reckoning will be.

Major Central Banks' Balance Sheets versus S&P 500 (Blue)

Motivating the US Dollar in the Meantime

There is limited capacity for the US dollar to respond meaningfully to the FOMC rate decision this month. Given how unlikely the leveraged scenarios of an accelerated rate hike path or unexpected withdrawal from its tightening regime are, there is very little value in preparing a full scale plane for such an outcome. Instead, more attention should be paid to the nuance that factors into deeper trends and establish what fundamental focus the market will transition to after the policy decision passes. It is still the case that the market has leveraged its Fed rate expectations to the point that updating them modestly - much less keeping them at the current level of buoyancy - will render little response from the dollar and US assets. A retreat, on the other hand, can undermine the reach for the USD but also spur concerns over the growth/financial outlook if the previously confident Fed decides to turn down the effort. In short-term speculative terms, dollar traders should keep close tabs on the short-term volatility from this upcoming event, but near-term trades should account for the influence a transitioning focus will have on the benchmark currency. The US NFPs on Friday is more than capable of charging volatility by commanding speculative attention. However, unresolved themeslike trade wars will linger at the fringes, and traders should stay flexible in their convictions and realistic in their trade time frames.

Equally-Weighted US Dollar Index

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