What needs to be said has already been said and now we wait. The markets have fully priced-in a 25bp to 1.0-1.25% range hike for this afternoon's FOMC rate decisions. We agree with the Fed that activity and inflation data has been stymied by transitional factors. We expected cyclical improvement in the 2H and anticipated another 25bp hike in December. Slightly less dovish commentary on economic outlook should see marginal repricing of US rate curve for 2017 and cause USD strength.
In regards to balance sheet reduction, we believe the Fed is not ready to announce their strategy for reducing its $4.5trn balance sheet (expectation for Sept). Yet that is really the rub, further Fed grinding movement towards normalisation either via balance sheet reduction or interest rate hikes are inherently hawkish.
In order to keep the USD weak, the Fed will attempt misdirection in order to keep the markets focused on Fed fund rates while they step away from supporting rates. We remain buyer of USDJPY given the pair’s high sensitive to US-JP interest rate differentials. The flattening of the yields curve indicated that markets are convinced of today’s hike (pushing short end higher) but uncertainty of futures hike (keeping long end low). Should our view prove correct, watch for US 10s yields to steadily climb well above 2.21% current levels towards 2.30% and USDJPY to 112.00. Elsewhere, US CPI and retail sales will be released likely adding general confusion heading into the FOMC.
By Peter Rosenstreich