Ahead Of The FOMC

  • US Federal Open Market Committee Rate Decision
  • Wednesday January 27th, 1900 GMT
  •  Current rate 0.50%, expected unchanged

December Meeting

The conclusion of the Fed’s December FOMC meeting came as expected with the Fed increasing rates by 0.25bps to 0.50%. The accompanying outlook for further rate increases was less Dovish than some were expecting with the Fed signalling a further four rate increases to come next year.

Alongside the higher than expected projected rate-path the Fed also raised its growth outlook for 2016 but at the same time lowered its inflation forecast. When questioned about inflation in the press conference which followed Fed chair Yellen stated that the Fed’s 2% inflation target will not have to be met before they raise rates again and reiterated the Fed’s stance that recent softness in inflation was due to transitory factors. Regarding global risk factors the Fed noted that risks from these elements persist but they have lessened since the summer and the domestic economy has shown strength.

Indeed, the Fed choosing to raise rates at this point was a sign of their confidence in the growing strength of the economy and despite some initial whipsaw as the release unfolded, the reaction was broadly USD positive with the USD index jumping higher on the decision, recouping part of the losses suffered from the December ECB meeting.

What’s Happened Since

The Dollar Index has continued to grind higher over the weeks since the December FOMC meeting supported by the Fed’s projected rate-path and stellar December NFP.

On the positive side

  • 3Q GDP printed above expectations
  • 3Q PCE printed in line with expectations whilst core printed above
  • Dec Non-Farm Payrolls printed strongly above expectations
  • University of Michigan Confidence printed above expectations

On the negative side

  • Dec ISM Manufacturing & Non-Manufacturing undershot expectations
  • Dec average hourly earnings missed expectations
  • Dec Retail Sales printed below expectations
  • Dec CPI printed below expectations

Fed Speak

Alongside these data release we’ve also had a raft of Fed member comments hitting the wires.:

  • Fed’s Evans voiced his support for a slower rate-path over 2016 citing inflation concerns and potential for lower economic growth.
  • Fed’s Lockhart opined that there likely isn’t enough new data to support a first quarter rate hike whilst remaining “mildly optimistic” about US growth.
  • Fed’s Bullard voiced his concerns over the “worrisome” drop in inflation expectations, led by lower Oil prices,  making it more difficult for he Fed to return inflation to target.
  • Fed’s Williams commented that despite the remaining presence of “significant headwinds” facing the US economy from USD strength and external factors, he sees the Fed progressing

The Global Picture

Since the December FOMC and the turn of the year, a few key themes have dominated markets:

  • Oil prices, which seemed as if they were stabilising into the end of 2015, have collapsed once again as the global supply-glut deepens, taking Oil sub $30 per barrel and dragging inflation expectations and risk sentiment down with it.
  • Alongside the continued slide in Oil prices, global risk sentiment has also been dampened by an intensification of concerns surrounding the slow-down in China with further data weakness from the world’s second largest prompting vicious selling in Chinese equity markets and global equity markets alike.

Expectations For This Meeting

Given the stark deterioration in the global-growth outlook and inflationary environment stemming from continued weakness in Oil prices, markets are not expecting the Fed to raise rates further at this meeting and it’s tough to foresee the Fed sounding Hawkish in tomorrow’s statement.

This meeting doesn’t include an update on economic projections nor a press conference and so the accompanying policy statement will be the only guidance for markets.

Domestic employment data shows strong momentum in the US economy though wage-growth is still dragging behind, however the impact of the slowdown in emerging markets is likely to have worsened with expectations building for a weaker Q4 GDP print. As we’ve seen recently with the BOE & ECB, inflation expectations are likely to be subdued with the continued slide in Oil prices and whilst the Fed stated in December that they don’t need to see inflation return to target before raising rates further they did note that they would be monitoring actual and expected progress of inflation towards their 2% target when deciding on further increases. With this is mind it seems reasonable to expect to Q1 to pass without a further rate increase.

Fed speak since the last meeting has highlighted the differing view points within the voting members and as the release of the December FOMC minutes showed, the decision to raise rates was indeed a close call for many members. With the worsening of factors most prominently threatening US growth and inflation targets, it’s likely that a consensus would be hard to reach again in the near term and some of these members would now dissent if the majority of members chose to hike again. Indeed the change in sentiment expressed by Fed’s Bullard, who was was one of the voting members arguing for an earlier rate hike on the ground that he expected inflation to rebound, highlights the difficulty facing Fed chair Janet Yellen.

The December Fed “dot-plot” projected four .25bp increases this year and it appears currently that there are significant downside risks to this projection. CME group shows markets expecting the first of the 2016 hikes to come at the June meeting. The minutes release from this meeting will certainly be one to keep an eye on to get a real sense of how the various members are viewing the projected rate path this year given recent developments.

Trade Ideas 

The recent heightening of market volatility and global growth concerns continue to drive safe-haven demand for JPY with CFTC data showing Non-Commercials have recently gone net-long the Yen for the first time in 4 years, pressing USDJPY down into key support over recent weeks. If the Fed do acknowledge a worsening of conditions since the last meeting and strike a Dovish tone we could see a break of this support in coming sessions where I would look to sell a retest of the level with stops above recent high (which would be current market levels) targeting a move down into 1.10.

The risk to this trade is that the BOJ announce further easing this week so traders need to be aware of the Japanese monetary policy statement on Friday.