The Federal Open Markets Committee (FOMC) is scheduled to meet late on Wednesday (16th Dec 2015 19:00 GMT) to set monetary policy. There are no guarantees apart from an extreme amount of volatility in the currency markets, so what are the potential outcomes?
Hawkish Raise
The market is predicting a raise in interest rates; in fact it is priced into the market somewhere between 70-90%. This will be the first rate hike since 2006 and the first rate change since December 2008, the depths of the GFC. The Fed has been talking up a rate rise for a considerable time now and all of their rhetoric and hinting points to this meeting as being it, so the market’s expectation is understandable.
They have the data to support a rate rise, although inflation could be better. Unemployment is at its strongest level since May 2008 and there are low amounts of spare capacity in the economy. The statement after the decision is going to be keenly watched for signs of future rate hikes. A rate rise might be the likely outcome, but a particularly hawkish Fed that commits to a series of rate hikes throughout 2016 at a similar rate as in the past is less likely. There is the risk that aggressive rate hikes (or any hike for that matter) will push the US economy back into recession, and the Fed will be aware of this. If this scenario eventuates, look for the US dollar to go ballistic and charge higher.
Neutral Raise
In my opinion, this is the most likely outcome; the Fed raising interest rates, but subsequently remaining cautious about the state of the economy. There is a general feeling that the economic recovery is slightly more fragile that it looks on paper, especially given the state of oil prices (knocking on the door of an 11 year low) and the economic slowdown in China.
The Fed will say something about how they will monitor the data and make a meeting by meeting decision on interest rates. Essentially they will be non-committal about future hikes so they can have some room to swing dovish if needed. If this proves true, the US dollar will be a rollercoaster. It will spike initially, but disappointment will set in and the gains could easily turn to sharp losses, depending on how neutral the Fed goes. The hike is heavily priced in, so the prospect of few (or no) rate rises down the road will be a disappointment to the dollar bulls. Stops will be triggered and the volatility will extreme, so best to just sit back and enjoy the fireworks.
Hawkish Hold
This is the second most likely outcome, but it will be a sharp disappointment to the market. The Fed has had no problem toting the December meeting as a “live” meeting which the market has taken as a clear signal that rates will rise. The hike is heavily priced in, so to not deliver will see panic selling as bulls try and unwind their long dollar positions.
There is a slight chance this outcome will happen. The Fed have managed to disappoint the market back in June and September when it was possible they could have raised then. The Fed will try on some damage control and suggest that the next meeting is definitely a live one, but the damage will be done. The US dollar will tank initially and it will likely be brutal. It may find some support as the market digests the statement and looks for any positives. The real question will be, is the Fed still credible? Will the market believe anything they say going forward? The Fed have made their bed and now they must lie in it.
Neutral/Dovish Hold
This outcome is the least likely of the outlined scenarios. If the Fed decides they do not quite have the data to justify a rate rise, they best talk up one at the next meeting. Failing that their reputation will take an even bigger hit than the US dollar. The implications will be far reaching, and economists will dig into the statement looking for justifications; perhaps the Fed sees a recession coming?
Janet Yellen and the Federal Reserve are due to set monetary policy, with the first rate rise in 9 years expected by the market. Volatility will be extreme, but the dollar may not rally, especially if the Fed is not as hawkish as the market would like. Best just to sit on the side-lines and enjoy the show. Now, where did I put that popcorn?