FOMC preview - page 3
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Here Is The 'Best Bang For Your Buck' If The Fed Hikes On Wednesday.
The message from Bratislava is that the UK is expected to trigger Article 50 early in 2016. The rest of the EU will apparently also make the terms for leaving really painful. Put those two together and you have a compelling case for PM May to delay for much longer, though the UK press also reports increased pressure from within the Conservative Party to get a move on.
Meanwhile, the suggestion that the Royal Yacht Britannia should be brought back into commission in order to help boost UK trade with the non-EU world may mark a new low point in the list of tactics to respond to casting ourselves adrift from our biggest trading partners. Sometimes, sighing is the only sensible reaction. None of this answers any of the big issues for sterling assets. My belief that ‘Brexit’ will have a long-term debilitating effect on the UK economy isn’t going to be shifted by this kind of nonsense, and I’m sure those who are optimistic that all will be well are equally unmoved.
But I still think Gilts are over-priced and I still think that sterling is vulnerable to another 5%-plus downside against both Euro and US dollar.
And since GBP/USD tracks short-term rate differentials where EUR/USD and USD/JPY are more sensitive to the long end of the curve, short GBP/USD may have the best bang for your buck if you do think the Fed could hike rates on Wednesday.
*SocGen maintains a short GBP/USD from 1.3750 targeting a move to 1.25.
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USD Into FOMC: Will This Be The Start Of A New Trend?
Fed may send conditional hints of upcoming hike:
The Federal Reserve meeting on September, 21 is likely to be eventful. While the FOMC is unlikely to deliver a rate hike, we think the committee will have to communicate that a hike is still likely before year-end. This means that the communication would have to sound cautiously hawkish, which is not an easy task.
We expect the FOMC to note that the balance of risks are nearly balanced and for the dots to shift down by 25bp across the curve. In our view, Fed Chair Yellen is likely to make the case for a hike before year-end in the press conference, but with an emphasis on the fact that it is dependent on continued improvement in the data.
FX Implications: Start of A New Trend?
The "cautiously hawkish" tone that we expect from the FOMC meeting is likely to be mildly USD-supportive, but we doubt it is the start of a new trend.
An upbeat economic assessment and nearly-balanced economic risks would support market pricing for a December hike, limiting USD downside, in our view. However, with the market pricing just over one hike between now and end-2017, we believe a necessary condition for the USD to rally is a consistent pattern of better US data allowing the market to price a meaningful pace of hikes in 2017 and 2018. Until then, the USD is likely to be range bound. That said, a residual expectation for Fed hikes is likely enough to limit significant USD downside given most G10 central banks are easing, but the dollar is unlikely to rally either.
Additionally, the recent shift by our US Rates Team's to a short real rates stance also suggests USD risks are more on the upside than the downside. The USD has benefitted over the past week as US real yields have risen between 6 and 18 basis points, driving a steepening of the rates curve. While the USD is typically negatively correlated with the shape of the yield curve, it has rallied because the curve steepening has been driven by real yields a relationship we have highlighted on many occasions. Should a real rate-led steepening of the curve continue, we would expect the USD to benefit. Indeed, the dollar continues to look undervalued relative to real yield differentials as we have noted recently.
However, we believe there are two risks around real yields for the dollar.
First, if the Fed were to more explicitly (through its Sep forecasts or communications) signal it will strategically overshoot its inflation target, real yields will fall, breakevens will rise and the USD will suffer. Our base case does not see this as a possibility for the September meeting, but Ethan Harris has argued the Fed could adopt this strategy to extend the business cycle allowing more room for rates to rise. Some belief that the Fed would stay 'behind the curve' on inflation earlier this year was a key reason for the USD selloff.
Second, if the BoJ focuses, as we expect, on maintaining policy flexibility as opposed to implementing significant new stimulus, the market could again interpret this as a policy constraint, pushing Japanese real yields higher, equities lower, and leading to a stronger Yen. This sentiment could spread to the ECB suggesting the USD would likely struggle against its G3 counterparts. This is why the BoJ meeting (happening hours before the Fed next Wednesday) is likely to be more consequential for FX markets than the FOMC.
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More from Barclays on the September FOMC meeting - expect a rate hike
The time has come The long-awaited September FOMC meeting has finally arrived, and we retain our out-of-consensus call for a rate hike on Wednesday.
Mixed economic data last week, including disappointing retail sales amid a solidifying CPI, coupled with dovish commentary by Board members Brainard and Tarullo, have reduced market expectations of a hike, with a 20% probability priced in. We see the likelihood of a hike as higher than market pricing, and there is scope for material USD strength if the Fed delivers.
If the committee instead stays on hold, more hawkish members will need to be placated with stronger language that points to a December rate increase. We would expect limited USD potential downside if this is the case.
The market will also pay attention to the FOMC's Summary of Economic Projections. We foresee a 25-50bp decline to the appropriate policy path, the ''dot plot''. We think the median member sees conditions as likely to support only one hike this year, and the appropriate policy path is likely to decrease by 25bp in parallel in 2017 and 2018. Given the very shallow rate path already priced in, the downward revisions should not have a meaningful effect, in our view.
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Fed policymakers begin two-day meeting, decision due on Wednesday
Policymakers at the Federal Reserve started a two-day policy meeting on Tuesday at 1 p.m. EDT, a Fed official said.
The meeting is due to finish on Wednesday.
Fed preview: reasons why no hike is expected and what to watch for
Financial markets and economists widely anticipate the Federal Reserve (Fed) to leave the price of money unchanged for ninth-straight month on Wednesday, but, assuming the U.S. central bank complies with market expectations, investors will pay close attention to the slightest hints for near-term changes to the path of policy normalization.
In general terms, the Fed is not expected to make a move on interest rates at the conclusion of its two-day policy meeting at 2:00PM ET (18:00GMT) on Wednesday, but investors will first focus on the statement and updated forecasts for economic growth and interest rates that will be released simultaneously with the rate decision for a first gauge on when the central bank contemplates returning to policy normalization.
Fed chair Janet Yellen will then follow up with what will be a closely-watched press conference 30 minutes after the release as investors look for any change in tone about the economy or future rate hikes.
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There is a strong case for a further small step towards policy normalisation and, although the Fed remains very reluctant to pull the trigger, hawks on the committee are likely to put up a strong fight.
Overall, the Fed is either likely to sanction a surprise rate increase with a relatively dovish statement or keep rates unchanged with a hawkish statement. Markets across all asset classes are certainly pricing in the latter and this may well be the outcome, but risk/reward makes it very dangerous to assume that interest rates will be left on hold.
There will be a much more substantial reaction if there is a surprise increase in rates with a dollar spike higher combined with sharp downward pressure on bonds and equities.
If rates are left on hold, there is a good case for buying dollar dips while fading gains in equities and bonds.
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Sep FOMC: 2 Important Changes; What's Next For USD?
The FOMC clearly signaled a hike before the end of the year in both the language and the dots. The Fed made two important changes to the statement.
First, the committee noted that near-term risks to the economic outlook "appear roughly balanced". This is an important step for the Fed to justify hiking rates at an upcoming meeting and is a page out of the playbook from last year. We expected the Fed to make thislanguage change.
Second, the FOMC noted that "the Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of further progress toward its objectives." This is a strong signal that the Fed is planning to hike in an upcoming meeting. It is not explicit calendar guidance, but it is a small step in that direction.
USD: What's Next?
The dollar was mixed in the wake of the FOMC statement. Cross-currents in the statement between three voters dissenting in favor of hikes combined risks to the outlook now being seen as nearly balanced were offset by downward revisions to the 2016-2018 dot plots. On balance, as we expected, today's meeting set the stage for a December hike, which will keep the USD supported (and downside limited).. But the slower pace of tightening as implied by the dots will limit USD upside to an extent as the magnitude of policy divergence continues to diminish with the Fed now only seeing 2 hikes in 2017 and 3 in 2018. As we have argued, a necessary condition for the dollar to rally is a more consistent pickup in US data so the market can price a faster pace of hikes in 2017/18. Until then any rallies will seem shallow particularly with the market already pricing a 60% of a hike.
The gradual pace of hikes implied by the SEP helps to maintain the divergent path of policy between the US and G10 economies, many of which continue to expand their balance sheets and ease policy. However, as the BOJ's action overnight highlighted, central banks are increasingly reaching the limits of policy. We see the higher real yields our US Rates team expects as USD-supportive, but a key risk is an inability for non-Fed central banks to generate inflation thereby pushing real yield differentials against the dollar.
Bottom line, the dollar will remain supported with the Fed on course to hike in December, but the magnitude of moves willbe hindered by the slower pace of hikes implied by the lowering of the 2017/18 dots in today's SEP.
Fed's Fischer says FOMC's September rate decision was "a close call"
US Federal Reserve vice-chair Stanley Fischer speaking at a banking seminar in Washington 9 Oct
Just caught these headlines as I was heading away. Hot off the press! Bloomberg reporting.
“Goldilocks” Nonfarm Payrolls Report Seen Strengthening Case for Federal Reserve Rate Hike
The US economy added fewer jobs than expected in September, but the underlying trend remained supportive of the idea that the Federal Reserve will resume normalizing monetary policy in the coming months.
Nonfarm payrolls rose by 156,000 in September, following a gain of 167,000 in August that was higher than initially forecast. The unemployment rate nudged up to 5% as more people entered the workforce. Over the past three months, job gains have averaged 192,000 per month.
Cleveland Federal Reserve President and Federal Open Market Committee (FOMC) member Loretta Mester described the report as “solid” and that it was “very consistent with what we expected to see.”
Mester, who was among the three FOMC members to vote in favour of a rate hike in September, told CNBC Friday that the economy was creating far more jobs than the baseline needed to keep unemployment stable.
“Remember 75,000 to 120,000 [jobs created] per month is about what you need to keep unemployment stable,” she said.
Fed Chair Janet Yellen said last month that the current pace of job creation was “unsustainable,” suggesting that the labour market had met the central bank’s target.
Prior to the NFP report, data on initial jobless claims, core PCE inflation and service sector activity all pointed to an improving economy. As a result, traders have gone significantly raised their bets on a December rate hike. According to the CME Fed Fund futures prices, the probability of a December liftoff is currently at 65.1%.
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Preview: Sep FOMC Minutes
The minutes from the September FOMC meeting are likely to reveal a heated debate about the appropriate course of policy. There were three FOMC officials - Kansas City's George, Boston's Rosengren and Cleveland's Mester - who dissented in favor of a rate hike at the meeting. At the other end of the spectrum, there were three FOMC officials who became more dovish, penciling in no hikes for this year. We think this divide reflects views around the costs/benefits of the Fed's accommodative policy. The three hawkish dissents were motivated, in part, by the belief that there are growing costs of easy policy including a misallocation of capital and potential brewing of asset bubbles. We therefore expect the minutes to reveal a discussion about the costs and benefits of keeping rates at the current low levels.
We also think the minutes will show a conversation about the degree of labor market slack. Fed Chair Yellen mentioned that the committee believes that there might be more slack in the labor market given the recent rise in the labor force participation rate and stagnant wage inflation. This would be a reason for a slow and delayed cycle.
Fed officials likely also discussed concern over low productivity growth and a structural shift lower in the equilibrium Fed Funds rate. Remember that the Summary of Economic Projections (SEP) revealed a decline in the long-run dot to 2.875% from 3.0% showing a more broad-based acceptance of lower long-run rates. This went hand-in-hand with a decline in trend GDP growth to 1.8% from 2.0%. The shift lower in equilibrium rates would also dictate a more shallow hiking cycle.
Overall, the minutes will provide something for everyone and reveal the growing divergence of views within the committee.
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