Key Points:
- Risks of FOMC meeting slanted to the downside.
- Market clearly looking for a strongly hawkish message.
- Fed likely to keep rates on hold whilst remaining ‘data dependent’.
As the market gears up for a key decision on interest rates from the U.S. Federal Reserve the reality is that most traders might be missing the risk of a downside move and over estimating the Fed’s ability and resolve to act. Subsequently, the greenback could be in for a rough ride if the Fed does exactly what I expect…nothing.
At this stage of the game, the central bank has carefully built expectations of ‘at least’ three rate rises for 2017. Subsequently, although most economists are not expecting the FOMC to hike rates at this meeting, they are expecting some hawkish rhetoric. However, they could be in for a huge disappointment given the changing economic conditions that the Fed currently faces.
Unfortunately, there has been no net change to the state of the U.S. economy since the last FFR event and, in fact, things might actually have deteriorated. Currently, Citibank’s economic surprise index is now in negative territory whilst the latest round of personal income figures gained an anaemic 0.2%. Additionally, consumer spending is also on the slide with the latest print returning a result of zero, which leads us to the next question of where the inflation is.
The reality is that inflationary pressures have largely been absent from the central bank’s version of the recovery with the last round of the PCE index coming in at just 1.6%. Subsequently, despite there being records levels of employment, and an unemployment rate below the natural level, we still do not have the kind of persistent price pressures that are likely to spur the central bank into action. There would therefore be little in the way of a case to continue normalising rates, at least with the current economic figures.
Therefore, it makes little sense that the market would be so convincingly Dollar long when the Fed’s current policy path is fraught with plenty of uncertainty. Presently, the risks are very much slanted to the downside, especially if the central bank provides a less than hawkish statement following the event. In fact, this could lead to a relatively strong USD depreciation which is likely to catch many retail traders unawares. Subsequently, watch your exposure during this event because the economic fundamentals are suggesting only one outcome and it will be unlikely to satisfy the bulls.
