Market Analysis

Heading Into The Fed

Wednesday’s rate decision and accompanying statement from the US Federal Reserve Open Market Committee (FOMC) will be the key focus for traders and has already attracted a plethora of commentary.  A hike of 25 basis points is expected so, once that is delivered, it will be the tone of the statement and the Fed’s forecasts which will be closely analysed. Canada’s TD Securities, writing Tuesday, felt “the [Fed’s] statement and Yellen’s press conference should look past the recent data softness and reaffirm three hikes and reduced reinvestments for this year” but felt too that “markets seem to expect a “dovish hike,” so unchanged median dots and talk of balance sheet runoff each risk a hawkish disappointment for markets.”

From a currency pespective, TD favours “a tactical bounce higher for the USD vs. JPY (USDJPY) but a shallower move vs the EUR (EURUSD).” Bank of America Merrill Lynch (BoAML) also thinks it will be difficult for the Fed to deliver another “dovish” hike while only 7 per cent of those polled in BoAML’s most recent Global Fund Manager Survey now think the dollar is overvalued, the lowest level since US President Donald Trump was elected. But, for the dollar to catch a post-FOMC bid, National Australia Bank, writing Tuesday, argues that would need the Fed to highlight “that the medium-term outlook for inflation or rates hasn’t really changed despite recent softer data.” US firm Morgan Stanley takes a firmer stance writing on Tuesday that Monday’s “sharp CAD appreciation on the back of [Bank of Canada] Deputy Governor Wilkins saying the [Canadian] central bank was looking at the possibility of raising interest rates, as the economic recovery picks up, indicated that there is a substantial risk of the USD rallying should the Fed underline its current rate projections.” In that scenario, Morgan Stanley calls the dollar index 2 per cent “higher from here in the next six weeks” but it too, like TD, feels dollar/yen might be the pair which attracts dealers’ attentions. Morgan Stanley takes the view that “higher US rates will increase Japan-based fund managers’ USD hedging costs, which should push USDJPY higher as they reduce their hedge ratios.” Four institutions, four views but all focusing, to varying degrees, on the risk that Wednesday’s FOMC decision could give the US dollar renewed energy. Traders will have to make their own judgements but it seems clear that with this Fed decision, it’s the accompanying detail that will matter not the headline rate hike.