Can you believe we’re down to the last FOMC statement of the year? Tomorrow at 7:00 pm GMT we’ll see if the Fed will deliver its widely-anticipated third rate hike for the year.
But first, let’s answer some of the more common questions around the release and see if you can get pips from trading the event:
What’s this I hear about a Fed rate hike in December?
Back in December 2015, the Fed pulled off a historic “liftoff” and increased its interest rates for the first time in a decade. Interest rates were pushed from below 0.25% to a range of 0.25% – 0.50%.
Janet Yellen and her team did an encore in December 2016 when they raised their rates to 0.50% – 0.75%. Thing is, the release’s “dot plot” showed that a lot of members are in favor of THREE rate hikes in 2017. Talk about stepping up their game!
Fast forward to today where the Fed’s interest rates is at around 1.00% – 1.25% after the central bank DID pull the trigger in March and in June. And just like Pipcrawler waited in line for the last installment of The Godfather in 1990, forex traders are now waiting to see if the Fed will walk the talk with a third rate hike.
How sure should I be about a rate hike this week?
Pretty sure. As you can see on the chart below, analysts were pretty much sold on a third rate hike since the September FOMC statement where board members shared their confidence that the factors dampening inflation are “transitory,” enough to keep the Fed’s dot plot pretty much unchanged.
About 87.6% of market geeks now believe that the Fed would raise its range to 1.25% – 1.50%, while 12.4% think that the Fed would boost rates to as high as 1.50% – 1.75%. At this point, NOT raising rates would have a more pronounced impact than an actual rate hike!
Fed members don’t seem too interested to crush rate hike speculations either. In the November meeting minutes, Fed members communicated that the economy is “rising at a solid rate” despite hurricane disruptions and that storm-related disruptions are “unlikely to materially alter” the economy in the medium term.
And while “some” members were concerned over how “temporary” low inflation really is, “several other” members remained confident that inflation would eventually pop high enough to warrant “additional firming” in the near term.
How could the dollar react?
Back in 2015 a lot of traders had already expected the Fed’s historic rate hike. However, they didn’t expect the extra oomph from higher growth forecasts and Yellen’s surprisingly hawkish confidence on the U.S. economy.
U.S. equity prices took off as a result, but the Greenback only scored participation points. One possible reason is that forex traders had already priced in the move and that they’re not willing to load up on their positions near the end of the year.
We saw the same thing in December 2016 when everyone and his momma had expected a rate hike, but were surprised by an anonymous vote, upgraded GDP forecasts, AND a more hawkish dot plot. This time the dollar jumped across the board and didn’t look back for the rest of the week.
If there’s anything we should learn about the last two December rate hikes, it’s that it’s not about the (priced in?) rate hike at all. Which brings me to our next question…
What other factors can affect the dollar’s price action?
In a nutshell, investors will be looking for hints on how aggressive the Fed’s tightening would be down the road. Here are a couple of factors:
“Dot Plot” chart
For newbies out there, you should know that the Fed’s “dot plot” is a handy visual that hints of the voting members’ rough interest rate biases for the years ahead.
As of their September release, members hinted that THREE rate hikes are likely next year, with CME Group’s closely-watched tool pricing in another rate hike by March 2018. Anything more aggressive than that will likely push the dollar higher.
Changes in economic projections
Back in December, the Fed’s upward revisions to its employment AND growth projections provided a bit more boost to the dollar’s bullish reaction.
In its September meeting, the Fed already upgraded its 2017 GDP projection from 2.2% to 2.4%, while 2018’s growth remained at 2.1% and 2019’s got nudged higher from 1.9% to 2.0%.
Meanwhile, unemployment is expected to hit 4.3% in 2017, before slipping to 4.1% in 2018 and 2019 while core PCE inflation is estimated to rise by 1.5% in 2017, grow by 1.9% in 2018, and rise to 2.0% in 2019. As in the previous December rate hikes, any further upgrades to the numbers could trigger another round of dollar-buying across the board.
Members’ future biases
FOMC members could be clear as day with their biases and market players could still shrug off their statements. See, between Dudley’s retirement, Yellen’s stepdown, Powell’s rise to power, and the entrance of Trump’s appointees, the FOMC’s Board will have a much different landscape next year.
Keep close tabs on the newbies’ biases on Trump’s fiscal (read: tax overhaul) plans and how it could affect the Fed’s game plan going forward. Oh, and keep in mind that the Fed is still in the process of normalizing its balance sheets, which could further discourage the Fed from being as aggressive with its tightening next year.
Trump’s tax speech
White House revealed that the POTUS will be giving a speech on Wednesday to communicate his plans to overhaul the nation’s tax code. And since it’s scheduled ON THE SAME DAY of the Fed’s expected rate hike, price action could be cray.