Key Points:
- FOMC likely to hike rates by 25bps.
- A lack of forward guidance from Yellen could send the USD reeling.
- FFR rate hike 100% priced in.
Global currency markets are facing a key risk event with the US Federal Reserve set to announce their direction on interest rates in the coming days. Normally, a tightening of monetary policy is a key positive event for the greenback but this time around we could indeed see a dollar depreciation as the market plays catch up with a lack of forward guidance from the central bank.
The Fed’s expectation setting for near-term rate hikes has been unassailable over the past month and the central bank would risk its credibility, and access to the expectations channel, if they failed to take decisive action on the Federal Funds Rate. Subsequently, Federal Fund futures are demonstrating a nearly 100% chance of a rate hike with most analysts, including myself, suggesting that a 25bps hike is the likely outcome of the FOMC meeting.
Such a decision would typically see the USD rallying sharply but this time around there are a few concerning factors to consider. In particular, there is a scenario where the FOMC hikes rates but Janet Yellen subsequently provides no forward guidance to rates which would leave the market open to form their own views. This could bring about a sharp decline for the USD given that many within the market are expecting strong signals of a tightening phase from the central bank.
In addition, Janet Yellen could also leave us with the old chestnut of a “Data Dependent” FOMC and continue to push the time-frames of a tightening phase further out into 2017. This would also have a relatively negative impact upon the dollar and leave the markets to consider whether we really are simply facing a `one-and-done’ scenario with rate hikes.
The reality is that as strong as the US labour market currently is, there is little prospect of a sustained cycle of tightening without some form of wage inflation flowing through the economy. At this stage we are not seeing some of the needed components to suggest some sharp increases to the FFR and this largely boxes Janet Yellen into a very tight corner. The Fed is obligated to hike rates, especially given their expectation setting in the lead up to the meeting, but they don’t currently have the set of macroeconomic conditions that would allow for a sustained cycle of monetary tightening.
Subsequently, the most likely scenario is one where the central bank hikes the FFR 25bps and then sends Chairperson Yellen before the cameras to espouse the FOMC’s ongoing philosophy of `Data Dependent Delay’. Given the current long-term yield curve, and requisite pricing in of a rate hike, this outcome is only going to end one way for the greenback and that isn’t one of ongoing bullishness.