Ahead Of The FOMC

 A look ahead of the FOMC October meeting with a summary of recent data and discussion of possible trade ideas.

  • US Federal Open Market Committee October Meeting
  • Wednesday October 28th, 1800 GMT
  • Current rate 0 – 0.25% expected unchanged

September FOMC Meeting

The FOMC September Meeting saw the Fed keep rates unchanged amidst growing downside risks to inflation and elevated concerns for global growth.FOMC members noted that global growth concerns would “likely put further downward pressure” on inflation and that Compared with their previous forecasts, more now saw the risks to inflation as tilted to the downside.”  However, the statement noted that the “Committee expects inflation to rise gradually toward 2 percent over the medium term” as the “transitory effects of declines in energy and import prices dissipate”

Regarding the economic outlook for the US the statement noted that “The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced but is monitoring developments abroad”

The statement was broadly in-line with Dovish expectations however the updated “fed funds dot plot” that shows the interest rate forecast of the FOMC members showed further Dovish developments with  four FOMC members now expecting no hikes until 2016 and at least one member forecasting negative interest rates in 2016. In the press conference following Yellen confirmed that “We would look at all of our available tools and evaluate it under that context” when questioned over the prospect of negative rates.

The statement also declared that “net exports have been soft” and in the press conference following, Fed Chair Yellen noted concern about the impact of the firmer USD,with net exports a substantial drag on growth in the first half of the year.

Market reaction saw USD trading sharply lower in reaction to the meeting.

What’s Happened Since?

Following the sharp USD selling in response to the meeting  the Dollar actually rallied in the days following the meeting only to be sold once again before finally trading higher once more ahead of the October meeting.  Data since the last meeting has been relatively supportive of Dollar strength.

  • September retail sales slightly undershot expectations at 0.1% vs 0.2% expected
  • September CPI came in flat at 0% vs -0.1% and core surprised to the upside at 1.9% vs 1.8% expected.
  • Unemployment for September remained unchanged at 5.1%
  • Consumer confidence beat at 103 vs 97 expected
  • Non-Farm Payrolls heavily disappointed at 142k vs 201k expected with the prior also revised down
  • ISM Non-Manufacturing missed as 56.9 vs 57.5 expected

Alongside the data release we also had the release of the September FOMC minutes which showed the meeting was indeed decidedly Dovish. Only one member voted for hiking rates at the September meeting with the decision to keep rates on hold passing as nearly unanimous whilst  the threat posed by external economic factors (China, EM’s) was clearly a significant concern. The minutes also revealed that FOMC members felt “the improvement in labor market conditions met or would soon meet one of the Committee’s criteria for beginning policy normalization.” Obviously since those comments were made we saw the release of the dismally low September NFPs and the lower revision of the August NFPs also.

Since the September meeting we have also had regular comments from Fed members hitting the wires. Fed’s Dudley has reiterated his commitment to a rate hike this year provided the economy performs in line with forecasts for inflation, growth and employment. Fed’s Williams also gave support for a 2015 rate-hike questioning the threat from the global economy saying that the Fed hadn’t received “any real information about a significant downturn in the global outlook,”  Fed’s Lockhart also expressed his support for a 2015 rate-hike commenting that despite recent troubles he sees a “liftoff decision later this year at the October or December FOMC meetings as likely appropriate,”. In contrast to these comments we have seen Fed’s Brainard stating she sees “the risks to the economic outlook as tilted to the downside” and urges against the Fed raising rates whilst global uncertainty remains.

The Global Picture

Outside of the domestic data front and the endless stream of Fed comments we have also seen some important developments on the global front.

Volatility stemming from the China slow-down has dissipated in the weeks since the Fed’s last meeting with Chinese data stabilising somewhat and as of last Friday,a fourth interest rate cut being introduced amidst constant speculation about the prospect of Chinese stimulus.

Commodity and energy prices have also remained fairly stable since the last meeting, stemming the declines which have plagued the Fed’s inflationary outlook so far this year, with Oil prices roughly unchanged from the September FOMC.

Alongside PBOC easing we have also seen the European Central Bank loudly confirm their commitment to fighting deflation by announcing at their October policy meeting that they are considering further interest rate cuts and expansion of quantitative easing, which will be reassessed at the December policy meeting. The reaction to this news and the Chinese rate cut was to see the Dollar strongly higher into the end of last week.

Expectations For This Meeting

The CME price only a 6% probability of lift-off at the October meeting, down significantly from earlier in the year. This pricing seems consistent with the market view that conditions for lift-off have likely not been met yet and the Fed will keep rates on hold in October.

Points to look out for

  • References to inflationary outlook. Have the Fed’s inflation forecasts materially changed? How does the Fed forecast the path of energy prices in the near term?
  • References to external economic factors?  How does the Fed regard risks from China/EMs?
  • References to domestic data. How does the Fed regard current economic conditions?

The increased downside risks from external factors and global deflationary pressures, whilst having stabilized somewhat in recent weeks, have clearly not disappeared and with more Fed members visibly troubled by these persistent risks, the almost unanimous decision to leave rates unchanged is likely to be the case this time around also.

The assessment in September that the committee saw  “the  risks  to  the  outlook  for

economic  activity  and  the  labor  market  as  nearly balanced” is also likely to still be the case. Whilst the most recent jobs reports have been underwhelming it is prudent to consider the fact that, as per comments made by Fed’s Lockhart, monthly jobs gains of between 100k and 200k are enough to keep up with labor force growth. Similarly Fed’s Williams commented that reduced payrolls gains are to be expected as economic expansion continues and economic slack diminishes. Notably unemployment is back its lowest levels since 2008.

The persistently low inflationary environment is of course still an issue for the Fed and whilst headline inflation remains low, some support will have been derived from the improvement in September core inflation which accelerated at the fastest pace in a year.

With Fed members clearly divided regarding the timing of a lift-off, as per recent Fed comments, of particular focus at this meeting will be whether any sort of consensus has been reached regarding the specific conditions and data developments members feel would adequately support a rate increase. Whilst no lift-off is expected at this meeting, clues as to the likelihood of a December lift-off will be the focal point and with no press conference following this meeting the language used in the statement will be particularly important.

Trade Idea

Hawkish Fed – Sell Euro

  • If the statement seems to strongly signal the likelihood of a 2015 lift-off, USD is likely to see firm buying. With the ECB’s recent policy announcements, a clear signal that the Fed are on course to raise this year will once again strengthen the quality of the policy divergence that had diminished somewhat over the year.
  • Currently sitting on a key support level towards the lower end of the channel, EURUSD should see a clear break below 1.10 opening up a retest of the rising channel support which may present an initial bounce but should ultimately give way as the policy divergence trade gathers steam into year end

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Dovish Fed – Buy Aussie

  • Commodity currencies have been the strongest beneficiaries of USD weakness in recent months and with the Aussie having managed to put in a near term base there certainly looks to be scop for further upside if the US Dollar weakens from current levels.
  • AUDUSD is currently sitting at a pivotal level with price having broken above the September high and now having pulled back into it as support, forming a wedge pattern that suggests further upside could materialise.
  • Look to buy a break of the upper wedge channel line targeting a move up through the October highs initially

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