The entire financial world sits and waits for the Fed’s next FOMC statement and press conference. With the US Dollar Index at the highs, the pressure builds on Powell to deliver a dovish statement.
But how can the Fed hike and still be dovish? Is such a dovish hike even possible? The answer is yes.
Powell knows very well that Trump’s administration isn’t happy with the strong dollar’s policy the Fed runs. Not once, Trump’s tweets blamed the Fed as the true enemy of the United States economy.
The pressure, therefore, builds for Powell and the Fed to deliver a dovish statement, even though the Fed most likely will raise the federal funds rate. Such a hike will push the interest rate to 2.5%, a staggering level for the world’s reserve currency.
When compared with other central banks’ jurisdictions around the world, the interest rate differential grows in favor of the USD. That’s not entirely visible on the Forex dashboard, despite the recent USD rise.
The EUR/USD fails to break and hold below the 1.13 level. GBP/USD keeps finding bids around 1.25 and USD/JPY is unable to push and stay above 113.
The USD, therefore, tells a different story than what the interest rate differential says, and this is what keeps the Fed on the rate hike path. As for Trump, as long as the economy outperforms (and it does!), all that matters is the stock market.
And that’s the main problem the Fed faces. A resilient stock market is an issue difficult to deal with, considering the inversed relationship between the interest rate level and stock prices. Conventional wisdom tells us that hiking the rates constantly hurts the stock market. Investors aren’t willing to take the risk associated with owning stocks and flee for the fixed income market.
However, the Fed did a great job communicating its intentions. Using wise forward guidance, it kept hiking for more than two consecutive years. In the meantime, the stock market didn’t collapse as many predicted. Instead, it merely corrected while keeping elevated levels.
With everyone wondering if we’re going to see the Santa rally, the key is in the Fed’s hands. It remains to be seen how to USD will react to the dovish hike as the pressure mounts for Fed to be dovish.