How The FX Market Will Likely React To Today's FOMC? - Credit Agricole

How The FX Market Will Likely React To Today's FOMC? - Credit Agricole

16 March 2016, 14:50
Vasilii Apostolidi
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The outcome of the March Fed meeting is the main event on the day and should attract considerable attention. The USD-investors will be looking for more conclusive indications about the timing of the next rate hike as well as the likely ‘glide path’ from here.

The FOMC has adopted a more cautious language in January to reflect the tightening financial conditions in the US (on the back of global risk off and weaker US data) as well as the lacklustre outlook for inflation (partly because of persistently weak oil prices). Since then, market conditions have improved in tandem with the US data and the oil prices have staged a rebound. While market measures of US inflation expectations remain close to the lows, core inflation gauges have accelerated, alleviating concerns about potential second-round disinflationary effects. Last but not least, the USD TWI came off sharply from its recent highs and helped ease the US financial conditions further, The changing fundamental backdrop in the form of easier US financial conditions and improving fundamentals should allow the Fed to signal greater confidence in the US recovery. Key for the timing of any rate hikes would be comments about the outlook for inflation. In January, the Fed no longer saw the risks to its outlook as balanced.

Gone was also the phrase that the Fed is ‘reasonably confident’ inflation will return to its 2%-target. A reinstatement of at least one of these statements could encourage investors to frontload rate hike expectations. In addition, the revisions of the ‘dot plot’ should be marginal so that it can continue to signal several (eg three) rate hikes this year. At present, investors are fully pricing in one Fed rate hike, to come only at the end of this year.

We suspect that the March Fed statement, the updated dot plot, growth and inflation forecasts as well as Yellen’s press conference could encourage some frontloading of rate hike expectations and that should support USD. A more constructive Fed view on the US could be perceived as hawkish and could add to the recent pick up in risk aversion.

As a result, we expect the likes of AUD, NZD, CAD and NOK to continue to underperform the USD. Liquid safe haven currencies like EUR, CHF and JPY could lose some ground as well even if they could prove more resilient in relative terms.

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