Fed 'certain' to raise rates optimistic commentary likely on tap Forex News Preview

Fed ‘certain’ to raise rates, optimistic commentary likely on tap – Forex News Preview

Posted on September 25, 2018 at 12:20 pm GMTMarios Hadjikyriacos, XM Investment Research Desk

The Fed is practically certain to raise interest rates by another quarter-percentage point on Wednesday at 1800 GMT. With such an action being fully priced in already, investors will probably focus more on the updated rate projections, economic forecasts, and Chair Powell’s press conference for fresh guidance. Given a booming US economy, policymakers are likely to appear optimistic overall, potentially providing a modest lift to the dollar.

Life is good if you are a Fed policymaker. Or at least, better than it has been for years. The US economy is booming, with fiscal stimulus boosting economic growth to above-trend levels, the unemployment rate hovering near two-decade lows, wage growth accelerating, and inflation as measured by the core PCE price index being exactly in line with the Fed’s 2% objective. Meanwhile, business optimism as gauged by the NFIB hit record highs lately, while consumer morale tracked by the CB survey rests at 18-year highs.

There are risks, of course, with the most notable being uncertainty around trade disputes manifesting itself into lower business confidence, thereby holding back investment plans by US firms and weighing on growth. Alas, nothing like that has shown up in the actual data yet, with the recent tax cuts likely helping to counterbalance the negative impact from trade worries. Moreover, the effect of tariffs has only been felt in a few industries, and given that international trade accounts for a relatively minor fraction of the US economy, many think the negative side-effects won’t be too dire.

Given this rosy outlook, markets have increasingly priced in more tightening by the Fed over the coming quarters. At the time of writing, a 25bps rate hike at this meeting is completely priced in according to the Fed funds futures, while markets also assign an 80% probability for a second one before year-end. Hence, the focus may fall primarily on any signals regarding the rate outlook beyond 2018, the updated economic forecasts for the US economy, and Chair Powell’s subsequent press conference.

With regards to the rate-path projections, also known as the “dot plot”, the median dot currently suggests two more rate increases this year, in line with market expectations. In 2019, the median “dot” points to three more quarter-point rate hikes. For that to be raised to four hikes, it would require that four policymakers revise their projections higher. While that may be too aggressive of a shift to materialize so early, the risks are still clearly tilted towards more officials revising their “dots” higher, not lower. In other words, although potentially falling short of clearly signaling four hikes for next year, the message would still be that the Committee is growing increasingly more confident.

Now as for the economic forecasts, the risks probably lie towards a more optimistic assessment as well. GDP growth for 2018 was revised up in June, and may well be reviewed higher this time around too, in light of a pristine Q2 print and mounting expectations for a robust Q3 figure. The Atlanta Fed GDPNow model estimates Q3 growth at an annualized pace of 4.4%, even higher than the 4.2% in Q2. While trade tensions would argue the opposite, the Fed typically places more weight on domestic developments, and – as already mentioned – trade uncertainties have yet to show up in US data.

Turning to the market reaction, the combination of a potentially more hawkish “dot plot” and the prospect for slightly higher economic forecasts would likely add the finishing touches to market expectations regarding a December hike, benefiting the dollar. Taking a technical look at dollar/yen, a first wave of resistance to advances may be found near the 9-month high of 113.16, where an upside break could see scope for a test of the 113.75 hurdle, defined by the December 12 peak. Even higher, the 114.70 territory – this being the high of November 6 – would increasingly come into view.

On the flipside, and in case the Fed appears cautious by placing more emphasis on trade risks, the dollar could tumble as a December hike comes into doubt. Declines in dollar/yen could encounter support around 111.75, an area that capped two advances during the last month. If the bears pierce it, attention would turn to 110.37, marked by the September 7 lows, with even steeper declines aiming for the August 21 trough of 109.75.

Finally, it’s worth mentioning this will be the first meeting that the new Fed Vice Chair, Richard Clarida, will attend and vote at. Given that he will hold the second most influential position at the Fed, which also grants him permanent voting rights, investors will be eager to see what his policy leanings are – and where he falls on the dove-hawk spectrum.

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