USD Reaction To The Fed Announcement? 3 Things To Watch

Nice to see you, nice to see you rise

Today is my Christmas; a day on which I and many others will receive a gift that has been a long time coming. Tonight’s Federal Reserve meeting, with the policy announcement due at 7pm GMT this evening, is set to start a new epoch for the global economy.

A recent survey conducted by us showed that 70% of UK SMEs felt their business could be better protected against exchange rate volatility. Today’s decisions will shape volatility heading into 2016.

The time is now

We have waxed lyrical many times before about the reasons that necessitate a rate rise in the United States. The data back us up too. The jobs market is strong enough given unemployment in the US has halved since 2009 and wages are starting to pick up. The US economy is growing well too, despite headwinds to contend with such as the Chinese and European wobbles throughout the summer, helped by low commodity prices. The timing of a rate rise is also important in that an early start means that increases can be slowly bled into the market so as to not shock a recovery into reverse.

It would also be a huge hit to credibility should the Fed once again pull away from the edge.

This morning’s Fed Funds markets are assigning a 76.0% probability of a rate hike; the highest probability of an increase in interest rates that has ever been seen heading into a meeting.

USD reaction: 3 things to watch

But what does the dollar do? We saw a stronger dollar yesterday but what happens after the decision? We need to focus on the three separate releases that make up today’s Fed decision; what happens in rates, the ‘dot chart’ of future rate expectations and Janet Yellen’s press conference.

Heading into the meeting we have seen a broad slump in USD positioning since the European Central Bank meeting a fortnight or so ago. Fewer people are as overextended in their bets on the dollar and therefore we can expect a slightly cleaner reaction to the announcement.

Based therefore on the presumption that we do see a rate rise today of 25bps, we would expect a knee-jerk of US dollar strength. The Fed’s attention will then turn to the ‘dot chart’ of future rate expectations. The latest iteration, released in September, showed the mean of rate expectations to see interest rates at 1.375% at the end of 2016 – should those dots be maintained at that level then we would expect further USD strength as the market rushes to price in an additional rate hike next year over current expectations.

There is a reasonable chance in our eyes that the Federal Reserve moderates the curve of these dot charts lower however, in a bid to emphasise the dovishness of the decision. In other words, rates had to come higher now but do not, under any circumstances, think that they are heading to the moon anytime soon. This may limit dollar appreciation.

Finally we have the press conference during which we expect Janet Yellen to attempt to continue the dovish tones. If she maintains calls for further rate rises to be data dependent and that the newly released economic projections show a continued pick-up in inflation expectations then the market will only have one trade in its mind; buy dollars and wear diamonds.

Elsewhere

Asia has been quiet in preparation for the meeting and we expect little movement from European markets through the session. GBP is slightly lower this morning following comments from Mark Carney that conditions in the UK are not ready for a Bank of England interest rate hike and a new poll on the EU referendum that showed a majority of people would vote to leave the EU should David Cameron not secure reforms on benefits for migrants or safeguard the rights of non-Eurozone states.

The UK jobs report is due at 09.30.