Trading The FOMC: Views From 12 Major Banks

Trading The FOMC: Views From 12 Major Banks

15 June 2016, 17:49
Vasilii Apostolidi

Deutsche Bank: Mixed Message.

We expect the tone of the June FOMC statement to be mixed: 

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Whereas the Fed can no longer definitively signal a July rate hike in the face of a possible labor market slowdown, it will also not entirely rethink its economic outlook. Therefore, as shown in the table below, we expect only minor tweaks to the Summary of Economic Projections (SEP). Importantly, we do not expect the median interest rate projections for 2016 and 2017 to fall. The FOMC will likely emphasize that it continues to expect “additional strengthening of the labor market”, while noting that domestic demand appears to be recovering. To be sure, the Fed’s assessment of consumer spending could be colored by today’s retail sales report. Moreover, the external sector showed tentative signs of stabilizing, as exports increased 1.5% in April. Given that the US equity market is near its historical high and global equity markets have been largely stable since the April 27 meeting, the Fed may indicate that global economic and financial developments have improved since earlier in the year. That said, long-term inflation expectations, as measured by the U. of Michigan survey, are at their lowest level ever (2.3%), and short-term expectations (2.4%) are also depressed. Additionally, the Fed’s five-year forward breakeven inflation rate has moved substantially downward. The Fed had until recently taken solace in the stability of inflation expectations. Therefore, the downturn in the latter will not go unnoticed by the FOMC.

Credit Suisse: Still Fading USD Divergence Ahead Of FOMC.

The market goes into this week's FOMC meeting seeing the probability of a hike as negligible, while pricing in only a 15% probability of a July hike. This pricing is fair in our view given impending Brexit risk on the external front and the soft recent employment data in the US itself. In addition, with inflation expectations now slipping again, the VIX near multi-month highs and major sovereign bond markets like Japan and Germany mired in sub-zero rates, there are no obvious market-based indicators begging for tighter monetary policy. We have faded the idea of buying USD on a "divergence trade" resumption view going as far back as February. We still do, but acknowledge that in the case of EUR and pro-risk currencies like CAD and MXN there is room for USD to gain ground in a risk-off world linked to European risk such as Brexit. Still, given that Fed chief Yellen's views on inflation assume no renewed USD surge, if one were to materialize based on global risk off, we would assume that Fed hikes in 2016 may end up being ruled out entirely, again removing any benefit for the USD on the basis. This suggests that the likes of CHF and especially JPY – typically viewed as even more of a safe haven than USD – are best placed to outperform in a risk-off world sparked by Brexit. We will be watching Fed chief Yellen closely nonetheless to see how she reacts to a) falling inflation expectations and b) the Brexit issue in her news conference.

RBS: Neutral FOMC; USD Mixed. 

Neutral (House View). While the median dot stays at two hikes in 2016, it does so barely as many more members see one hike (and potentially zero). Yellen’s press conference mirrors her June 6th speech by focusing on “uncertainties” and “questions” recently raised, as well as concern over inflation expectations. Characterization of last month’s NFP print and its relevance for the broader economic trajectory is more balanced.  Market Reaction: In rates, our view is that this scenario validates current market pricing, which will continue to appropriately under-price the Fed. Even so, this boosts the front end, especially into the UK Referendum next Thursday. So a small bull steepener. In FX, the dollar may be caught between safe haven demand for USD and softening fundamentals and dovish Fed, making its performance mixed. Similar to above, we prefer to play dovish-FOMC-related USD weakness against the safe-havens (CHF, JPY) because of our sense that the referendum may weigh on risk appetite more broadly.

Morgan Stanley: Old USD Playbook Back In Use.

The USD may consolidate some of its recent gains ahead of today’s release of the Fed statement as the Fed may take some of its dots lower and cite some global uncertainties including the recent rise of volatility weakening financial conditions.What is important for the USD outlook is if the Fed maintains its tightening bias or not. At this stage there is very little doubt about the Fed maintaining its tightening bias suggesting the interpretation of economic conditions of the rest of the world turning into the swing factor driving USD strength. It looks like last June’s playbook being used again. After the Fed, we believe the USD is set for further gains with recent indications of US domestic demand holding in quite well (yesterday May control group retail sales (0.4% M) exceeded expectations following an upwardly revised April gain (1% M)) within an otherwise slowing global economy helping the USD too.

BNP Paribas: Fed Decision Is Unlikely To Revive USD.

 We expect the FOMC to continue to send an optimistic message today, with the dot plot continuing to centre on two hikes in 2016. However, Chair Yellen will also likely reiterate her concerns about the latest jobs numbers and do little to encourage increased pricing for a July hike. We think the USD remains vulnerable against this backdrop, though possible BOJ easing this week should limit USDJPY downside for now.

SocGen: A Non-Event; Focus On 'Dots'.

FOMC days are odd – the highlight is in the early evening and is often generally expected to be a non-event anyway. We will get new growth and inflation projections and a new set of ‘dots’ to show us where the FOMC members say they think rates will be going forwards. All of that will be more interesting than the actual policy decision.

Credit Agricole: A Non-Event; Focus On 'Dots'.

The June FOMC meeting is likely to prove uneventful with policy widely expected to be unchanged, and the statement and press conference unlikely to signal a near-term rate hike ahead of the Brexit and June jobs report. In this respect the updated dot-plots and SEP will draw greater attention. We believe Fed expectations for continued rate normalization this year remains intact, especially in light of the May retail sales report which gave further evidence that the economy’s growth engine is alive and well.We expect the FOMC median to rest at 2 hikes for 2016 (in line with our view) given the multitude of Fed officials recently stressing 2-3 rate hikes this year. The pace of normalization in 2017 and 2018 and neutral Fed funds rate will be noted. With Yellen’s emphasis on unusually weak productivity, disappointing wage growth and low inflation, downward revisions cannot be excluded.In any case, market rate expectations should remain low but are unlikely to fall further, with post-Brexit incoming data (notably the next jobs report) and subsequent Fed rhetoric to drive the USD. With market rate expectations capped in the interim, the USD should struggle particularly against safe havens such as the JPY. Nonetheless, this is based on the assumption the BoJ refrains from any surprises tomorrow as forecasted by our economists.

Goldman Sachs: Focus On The Long Run 'Dots'.

We expect the Fed to stand pat thus week, but to keep a rate hike in the near future on the table. We expect small changes to the economic outlook, and for the median funds rate estimate in the Summary of Economic Projections (SEP) to remain unchanged for this year; the pace of rate increases beyond this year will probably come down. If, as our economists expect, the long run target falls by 25 bps to three percent, this would be the third time that the long run target rate has been cut since September 2015 and could signal that the Fed is gradually losing confidence in the kind of tightening cycle that history demands, in line with a recent FX Views where we argued that China’s RMB problem may be causing the Fed to be more dovish all else equal. If there is such a reduction in the long run rate, we see scope for the Dollar to weaken somewhat further today even with Fed Funds futures pricing less than two hikes over the next two-and-a-half years. If, instead, the long run rate remains unchanged, this could signal a Fed that is not re-evaluating its basic framework for policy normalization and could see the Dollar rally in coming weeks, especially if uncertainty around the British referendum is resolved in favor of a “remain” outcome.

Barclays: A Non-Event; USD Range Bound Into EU referendum.

We expect the FOMC to be a non-event because a hike is likely off the table after the employment report and with markets pricing the same scenario. The policy statement will probably include a small downgrade to the assessment of labor market conditions, but on balance should keep a positive outlook, consistent with a tightening bias in the months to come. Regarding the economic assessment, we expect small downward revisions to the median 2016 forecasts of the unemployment rate and GDP growth but the median dots to continue to imply two hikes by year-end. Therefore, we still forecast the USD to trade range bound in anticipation of the EU referendum.

BTMU: On Hold; Focus On 'Dots'.

It is now viewed as a certainty that the Fed will not resume rate hikes at the upcoming FOMC meeting. The updated Fed statement may echo recent comments from Fed Chair Yellen which were cautiously optimistic acknowledging the strong rebound in personal consumption early in Q2 but warning that labour market conditions will have to be watched closely now. We do not expect the Fed to provide calendar based forward guidance over the potential timing of the next rate hike. The updated dot plots will be watched closely to see if the Fed still plans to raise rates twice this year. The US dollar will be vulnerable to the downside if the number of planned hikes for this year falls to just one. It is more likely that the Fed will reduce the number of hikes planned for next year and in the long-run which would weigh more modestly on the US dollar.

BofA Merrill: A Tactical Delay; USD To Consolidate At Current Levels.

Because this meeting represents a tactical delay by a data-dependent Fed, we do not expect a fundamental shift in the Fed’s outlook. As a result, the statement language and Summary of Economic Projections (SEP) are likely to see relatively few and mostly minor changes, other than marking to market as needed. In particular, despite the market continuing to further reduce the likelihood of a rate hike at subsequent meetings (Chart of the day), we think it is not all that likely the median dot will shift down for this year or the next two.In addition, while Fed Chair Janet Yellen is unlikely to offer any explicit signals on the timing of the next rate hike, we anticipate she will likely affirm that the FOMC expects it will be appropriate to raise rates later this yearAs such, the market may view the outcome of the June meeting as slightly hawkish....With a rate move off the table, the USD will likely respond to any signal of action at coming meetings the FOMC gives. Chair Yellen’s balanced tone in her recent Philadelphia speech suggests we would not see a repeat of the October 2015 statement when the FOMC specifically laid out conditions they wanted to see before raising rates at the “next meeting.” We remain biased toward further USD consolidation around current levels with the focus more likely to be on this week’s BOJ meeting and next week’s EU Referendum in the UK.

Danske: Wait & See Approach; EUR/USD In 1.11 -1.15 Range.

We believe the Fed will adopt a ‘wait and see’ approach. The two weak jobs reports are concerning but it seems too early for the Fed to change its economic outlook significantly at this point. We still expect it to hike in September but risks are skewed towards a later hike as it would require a rebound in employment...We see EUR/USD in the 1.11-1.15 range but see risks skewed to the downside in coming months. The FOMC meeting this week is likely to be neutral for EUR/USD but a Brexit would drive a move lower in EUR/USD as the market would focus on rising political uncertainty in the Eurozone. In case of ‘Bremain’, we expect any rally in EUR/USD to be capped by expectations that the Fed is likely to raise interest rates in September. On a 6-12M horizon, we continue to expect EUR/USD to rise substantially on the cheap valuations of the EUR and the wide Eurozone-US current account differential. We forecast EUR/USD at 1.18 in 12 months.

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