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Fed Preview: It’s A Credibility Issue For Yellen

By Kathy LienForexJun 13, 2017 03:06PM ET
www.investing.com/analysis/fed-preview:-it%E2%80%99s-a-credibility-issue-for-yellen-200194955
Fed Preview: It’s A Credibility Issue For Yellen
By Kathy Lien   |  Jun 13, 2017 03:06PM ET
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By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

On the eve of the Federal Reserve’s quarterly monetary policy announcement, no one is buying U.S. dollars. The greenback ended the day lower against the Japanese yen, sterling, Canadian and New Zealand dollars and was unchanged versus other major currencies. Even the strongest rise in annualized core producer price growth did not spark lasting demand as investors eye the rate decision with caution. The problem is that everyone expects the Federal Reserve to raise interest rates by 25bp on Wednesday so the rate change will be the least interesting part of Wednesday’s monetary policy decision. Instead, investors will be focused on the dot plot, changes to the central bank’s economic projections, the tone of Yellen’s speech and their plans to reduce the balance sheet. There’s significant debate on how the Fed approaches each of these issues so fireworks are expected. The dollar, which has been trading quietly versus the yen and euro ahead of the decision, will most likely break out of its 1.1165-1.1285 EUR/USD and 109.50-110.50 USD/JPY range.

3 Questions For The Fed

  1. Will the dot plot still show 1 more hike in 2017?
  2. Will the Fed provide details on how it plans to reduce its $4.5 trillion balance sheet?
  3. Will Janet Yellen stand firm on her view that stronger labor-market conditions will take inflation back to target

If the answer is 'YES' to all of these questions, the dollar will rise, otherwise, it’s a sell on rally.

This month’s FOMC rate decision is about credibility. The following table shows more improvement than deterioration in the U.S. economy since the last meeting but none of us can forget the big disappointment in nonfarm payrolls this month. Economists were looking for 185K jobs and only 135K jobs were created. This follows a downward revision the previous month and a staggeringly weak 50K increase in March. The economy is not performing as well as the Fed has hoped and there’s no clear timeframe on tax cuts or fiscal stimulus. The political drama in Washington is stifling progress on economic stimulus. To forgo raising interest rates would be a major credibility issue for the Fed because U.S. policymakers have taken every opportunity to say that 1 to 2 more rate hikes are needed this year. Unfortunately, their credibility will remain in question if they tighten because weak data leaves the Fed stuck between a rock and a hard place. Thankfully, time is on their side with investors not looking for a follow up move until December.

With 6 months to go before the December meeting, we think it is too soon for policymakers to drop their call for one more hike in 2017. Their credibility would take a major hit if they shifted guidance and then changed shortly thereafter as data improves. So while we expect Yellen to recognize the down drift in inflation and softness in data, she will also provide details on reducing the balance sheet. If her tone was cautious back in March, it's only going to be more so in June and that’s why we believe that unless she is overwhelmingly hawkish, keeping the door open to another hike in September, the rally in the dollar should be sold.

USD Data Points
USD Data Points

Meanwhile, positive political and economic developments sent sterling higher against all of the major currencies. There’s talk of a coalition agreement between the DUP and Conservatives. Consumer prices grew at its strongest pace in 4 years with core consumer price growth hitting its highest level since 2012. This increase was a surprise and was powerful enough to driver short covering in sterling. We still think GBP is a sell on rallies with the latest recovery mimicking the move in 2010 when GBP/USD rebounded off its post-election lows only to break the low by 250 pips after a Coalition government was announced. With that in mind, U.K. labor data is scheduled for release on Wednesday and stronger job growth is expected as the manufacturing sector saw its greatest improvement in jobs in 3 years according to the PMIs. We like selling GBP/USD between 1.2790 and 1.2830 though EUR/GBP would be a better trade as there is no embedded USD–FOMC risk.

Tuesday's best-performing currency was the Canadian dollar, which extended its gains on the back of Bank of Governor Poloz’s comments. Although he was not as explicit as Wilkins, who questioned the bank’s easy monetary policy, Poloz said interest rates have been extraordinarily low and have done their job. Combined with the rise in oil prices, his comments took USD/CAD within 10 pips of 1.32. The break of the 50- and 100-week SMA means that further losses are likely with a possible drop down to 1.3050. The New Zealand dollar also pressed higher but lower business confidence prevented the Australian dollar from participating in the rally.

The euro also ended the day unchanged against the greenback. Although investors grew less optimistic about Germany’s economic outlook, they felt better about current conditions in the Eurozone’s largest economy and the outlook for the Eurozone in general. For this reason we continue to expect euro to outperform the GBP. EUR/USD will also be a good trade if the Fed disappoints.

Fed Preview: It’s A Credibility Issue For Yellen
 
Fed Preview: It’s A Credibility Issue For Yellen

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John Milosh
John Milosh Jun 16, 2017 10:39AM GMT
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Thanks for the quality market coverage.
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Spp RTT
Spp RTT Jun 15, 2017 1:34PM GMT
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no exact info was given about EUR/USD, just common phrases. can go up can go down ( of course its obvious that will do so)
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Paul Karimanzira
Paul Karimanzira Jun 14, 2017 1:04PM GMT
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Well informative , thanks very much Kathy
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Kim boesgaard Lauritsen
Kim boesgaard Lauritsen Jun 14, 2017 9:46AM GMT
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Hey Kathy, thank you very much for that analysis i always value them, hope you are having a great day:-)
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vin me
vin me Jun 14, 2017 1:53AM GMT
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JY has no credibility. Liquidity is creating wealth concentration. civil war in few years
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Stanley Emmy
Stanley Emmy Jun 14, 2017 1:43AM GMT
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Kathy, thanks a lot. Well done!
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Katrina Stinebaker
Katrina Stinebaker Jun 14, 2017 1:00AM GMT
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Thank you! Nicely written.
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Hice Hice
Hice Hice Jun 14, 2017 12:55AM GMT
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Very nice.
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qu liang yang
qu liang yang Jun 13, 2017 11:57PM GMT
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Thanks for your information.
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Bir Bami
BirBami Jun 13, 2017 9:09PM GMT
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Very informative commentary, as always. Thank you.
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MD AL AMIN MAZUMDER
MD AL AMIN MAZUMDER Jun 13, 2017 8:32PM GMT
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Thanks to you for kind information
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