June FOMC Preview: A Tactical Delay
FOMC to Rock the Dollar - Latest Views from Goldman, Morgan Stanley, Westpac and BofA
The next phase in the US dollar's evolution will be determined by the outcome of the upcoming US Federal Reserve
policy meeting will determine whether the US dollar’s poor June extends
- Fed funds markets are assigning a zero probability of an interest
rate in June but they will be looking for hints that a July rise will
take place. If this is the case, then the prospect of a second rate rise in 2016
becomes possible - something that will be music to the ears of dollar
bulls. The promise of higher US interest rates in the future remains the
life-force behind the dollar’s multi-year cyclical upturn which has
stalled over recent months. With no interest rate rise forecast this week markets will be scrutinising the wording and tone of the accompanying statement. “The likelihood is we see a repeat of Janet Yellen’s recent speech:
that they want to put up rates, but it purely depends on the outcome of
potentially destabilising events, such as the UK referendum. The Fed
will be happy to raise with corporate credit spreads narrowing, but the
US yield curve is a clear issue at 91 basis points. Falling inflation
expectations are a huge concern, not just for the Fed but many other
central banks,” says Chris Beauchamp at IG in London. IG is expecting a slight downgrade to their growth forecasts for 2016
and 2017, with a shift lower in their view on where interest rates are
likely to head in 2017 and 2018. “Recall, interest rate traders are positioned significantly more
negatively than the Fed’s own projection, so there is a chance we see a
modest USD rally,” The Federal Open Market Committee (FOMC) will update its economic and policy projections at this meeting. The most likely change will be a modest shift lower of the dots for 2016, and probably for 2017 and 2018 as well. The dots being referred to is a chart that shows where each
participant in the meeting thinks the fed funds rate should be at the
end of the year - for the next few years and in the longer run. Take a look at the March meeting’s dot plot chart: As we can see, the majority of members see it appropriate that the Fed has a base rate of 0.75% by year-end. “With a majority of 9 among 17 members calling for 2 hikes in 2016 it
seems unlikely the median will shift in the 2016 dots. This group would
need to move almost en masse to force that median down to 1 hike,” says
a briefing from Westpac Institutional Bank in Sydney. “The
distribution of dots around that median should take on a dovish bias
though, certainly the 7 calling for 3 to 4 hikes this year could see
some trimming, if only because there is one less meeting this year.” The long term neutral rate (3.25%) probably comes down another 25bp,
as it has done so at virtually every dot plot refresh in recent years.
“All told hardly a USD bullish backdrop,” say Westpac. Westpac have told clients this week that they see it appropriate to be long on the euro / dollar exchange rate as a result. Bank of America Merrill Lynch’s Michael S. Hanson agrees
that the most likely change will be a modest shift lower of the dots for
2016, and probably for 2017 and 2018 as well. However, “the median number of hikes is likely to remain at two for
2016, while we see a relatively low probability that the median number
of hikes for 2017 or 2018 will decline to three from four: for 2017,
that would require all five Fed officials currently signalling four
hikes to switch to three,” says Hanson. In the statement, the FOMC is expected to acknowledge that the employment situation has softened recently, hardly surprising in light of this month’s poor payroll report. Nevertheless, some expect this negative to be offset by suggestions
that the US has reached full employment and by noting that
current-quarter GDP growth is expected to be stronger. Bank of America believe it is also unlikely that the Committee will
provide any indication of policy action at subsequent meetings beyond
the standard language in the statement; any such hints would be seen as
hawkish by the markets and could well boost the US dollar. Striking a more optimistic tone are Goldman Sachs, where analysts
argue, "it is much too soon to sound the alarm," following the poor
employment report. Goldmans argue that too pessimistic a tone has been struck over the
report noting that adjusted for the Verizon strike, payroll employment
growth was not much below our estimate of its trend or “breakeven”
level. And, "downward revisions to prior months reflected seasonal
adjustment changes, so we would caution against extrapolating a trend." Further, other labour market indicators, such as jobless claims, have
held up better. "We see a slowing, not a slump, in the latest labor
market data," argue Goldmans. "We expect the Fed to stand pat next week,
but to keep a rate hike in the near future on the table." The big question then is whether or not the Fed can shift the dollar’s fortunes? Analysts are in agreement
that the weak May NFP report eliminated the possibility of a June FOMC
hike, particularly ahead of a still close EU Referendum in the UK
(according to opinion polls). “The FOMC statement and Janet Yellen's press conference will still
rock the dollar because investors are on the fence about the timing of
the next rate hike,” says Kathy Lien, an Director with BK Asset
Management. Lien says if Yellen refrains from saying that rates could rise in the
coming months and expresses concerns about the economy, the dollar will
extend its slide. But if she is even slightly more hawkish than the market expects, the dollar will rise quickly and aggressively. “The USD’s price action in response has been severe as it registered
its largest daily change on a negative NFP surprise since 2001.
Historically, these moves persist underlying our continued cautious
stance,” says Bank of America Merrill Lynch’s FX Strategist Ian Gordon. Gordon believes that with a rate move off the table, the USD will
respond to any signal of action in coming meetings the FOMC gives. Chair Yellen’s balanced tone in her recent Philadelphia speech
suggests we will 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.” “Such a move would be USD-supportive alongside a rise in front-end
yields. However, given our expectation for the FOMC to adopt a cautious,
data dependent stance, it is The question of whether the dollar can advance further rests with how
the Federal Reserve reads the slowdown in the US labour market argues
Hans Redeker at Morgan Stanley. Will the Fed take the view that the slowdown in hiring is because the
labour market is approaching NAIRU and the decline in new-job creation
will come along with rising wages? (Non-Accelerating Inflation Rate Of Unemployment
- NAIRU - is the natural state of equilibrium between the state of the
economy and the labour market. If the US has achieved this then the
slowdown in wages is unlikely to be of concern). The Beige Book reporting tighter labour market conditions in 14 districts and average hourly earnings holding steady at 2.5% may be evidence of this. “In this case, the Fed would keep its tightening bias intact, pushing
the USD higher, and we would be wrong to make the above adjustments to
our portfolio,” says Redeker. But what if the US economy really is in worse shape than it appears? “We would certainly then see the Fed maintaining its dovish tone and pushing out rate hikes even further,” says Redeker. All in, Morgan Stanley stay firmly convinced that the USD's secular bull market is not yet complete. “Should US wages turn higher, the USD would likely move higher later
this summer. Should the US been entering a cyclical slowdown, the USD
would have more short-term downside potential of around 5% from here,
before EM overcapacity worries put the USD back into its bull trend,”
says Redeker.The US Federal Reserve policy decision on Wednesday is forecast to give fresh impetus to foreign currency markets this week.
Movement in the Dots Could be Where all the Action is
Too Soon to Sound the Alarm say Goldman Sachs
Can the Dollar Recover?
unlikely the FOMC will alter the
dollar’s recent fortunes, and indeed will weigh on the USD further
through a continued decline in real yield differentials. Therefore, we
remain biased towards further USD downside,” says Gordon.The Dollar’s Advance is Not Yet Done: Morgan Stanley
USD into FOMC: Old playbook back in use - Morgan Stanley
Morgan Stanley on the FOMC decision
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.
What changed in the FOMC dot plot and economic projections
How Fed estimates changed
- 2016 growth downgraded to 2.0% from 2.2% in the March projection
- 2017 growth downgraded to 2.0% from 2.1%
It's officially a 2% economy (and the Fed has a history of overestimating)
- Unemployment forecasts for 2016 and 2017 unchanged
(There was some speculation the 2016 forecast of 4.7% would be lowered because we're already there)
- 2016 PCE inflation raised to 1.4% from 1.2% but 2017 and 2018 unchanged
(This is likely due to the rebound in commodity prices)
- Longer-run Fed funds rate estimated at 3% versus 3.25% in March
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Between weaker May jobs data and uncertainty ahead of the UK referendum on EU membership, the markets have completely priced out any chance of a June rate hike. We concur, as this will give the Federal Open Market Committee (FOMC) more time to reassess global risks and incoming US data. While we cannot completely rule out a July hike, the hurdle for a quick improvement in the data and supportive financial conditions is relatively high. Our base case remains a September rate hike.
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 year.
As such, the market may view the outcome of the June meeting as slightly hawkish.
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