The FOMC is about to deliver its quarterly policy announcement, which includes its interest-rate decision, updated projections and a press conference with Janet Yellen. The second rate rise of the year is seen as a done deal in the market with the CME pricing it at 96%. So it is the forward guidance and general tone of the statement, which will be key for markets. The chances of a third interest rate hike of the year in September have dropped dramatically since the disappointing June payrolls figures down from 65% to the current 21%. The probability of a rate hike in December has also dropped from above 50% to 31%.
Dot Plots
Forward guidance will initially come in the form of the Fed’s rate cycle outlook – the ‘dot plots.’ Important here will be whether the scenario of three hikes for this year is unchanged. It is notable that this third hike is only fully priced for the third quarter of next year so market rate expectations are somewhat shy of the Fed’s forward rate path. That said, if there are any adjustment here towards the current market pricing, then it will interesting to see if the market gets concerned about a repeat of the 2015/2016 scenario.
Balance Sheet
Many in the market are expecting some color on the Fed’s +$4.5trillion balance sheet and any plans for ‘quantiative tightening.’ This tapering will be important going forward, especially as the last minutes mentioned only ‘gradually scaling back reinvestments’.
Press Conference
Of course, Yellen’s press conference will then finish the meeting and offer huge additional insight into the Fed’s thinking. We think market consensus is that the FOMC will stick to previous guidance for another hike before year-end, while continuing to acknowledge the transitory nature of current inflation weakness. Here, we note the third straight month of falling US PCE data, which is starting to impact some Fed members who have recently stated their unease about this and how it could change their future policy intentions. How Yellen therefore balances up weakening inflation and data with low wages and full employment will be fascinating. (A conundrum for all central bankers it would seem!)
Having just had disappointing inflation and retail sales data, the dollar is in a downtrend with 10-year yields now below last week’s lows around 2.13% and under its 200-day moving average. This is down from their highs of 2.63% after the two previous hikes. With the dollar index currently hovering below its six month lows of 96.63, it would appear that the markets had already discounted a ‘softening’ Fed.
Interestingly for us, the major currency pairs like EUR/USD, USD/CHF and USD/JPY had all been coiling and compressing in ever-tightening trading ranges. Before the US data today, we were experiencing the narrowest ranges in several sessions for these pairs, which meant price range expansion was imminent – we have obviously got this price action, so the dollar is now in desperate need of respite from the Fed and Janet Yellen. That said, with the yield curve flattening and at its lowest since last October, the market has taken its stance on the Fed already.
