The long-awaited FOMC meeting contained few surprises. There weren’t any major changes to the economic outlook – some small changes in the growth and inflation forecasts, but nothing worth noting. The key point is that there was no change in the median dots in the notorious “dot plot,” which indicates that the consensus on rates hasn’t changed either way.
Moreover, the new forecasts for 2021 showed that the Committee sees the rate hiking cycle coming to an end by 2020 – the median estimate for 2021 is the same as for 2020 (in fact, the average is a tiny bit lower because several people dropped their forecast, implying that they think a rate cut is a possibility in 2021, but only one raised their forecast.)
The longer-term forecast edged up slightly, but this was probably due to the addition of the new Vice Chair, Richard Clarida, and so it does not indicate a change in views.
US Treasuries rallied strongly across the curve, with most of the move occurring during Chair Powell’s press conference.
The general pattern is for the USD to strengthen (i.e., for EUR/USD to decline) following a rate hike. The graphs below show the average move after a meeting when they hike rates and when they don’t hike rates. The subsequent graph shows in more detail what happened after each of the last six rate hikes. As you can see, EUR/USD fell (i.e., USD strengthened), four out of the last six times.
This time however I’m not so sure that’s going to happen. In this case, the market had not only priced in a rate hike at this meeting but also pretty much priced in one at the next meeting too. As the graph below shows, the probability of a fourth rate hike this year has been rising steadily and now is estimated at 71%, which is pretty strong.
The press conference following the meeting reinforced the likelihood that there would be a rate hike in December, but at the same time, Powell implied that the bar for a change to their plan of one rate hike a quarter, more or less, is pretty high – inflation would have to accelerate sharply in order for them to hike at a faster pace than currently forecast. That just doesn’t seem likely at this time. Accordingly, the Fed’s rate path is pretty well priced in now, leaving not much for the market to go for. That suggests to me that there could be some profit-taking setting in from here.
Given that the US rate-hiking cycle is nearing its end – three hikes forecast for next year, and only one after that – while other countries are just beginning theirs, it’s difficult to see how the USD can continue to outperform. The only way would be if the US economy were to surprise on the upside, making further rate hikes likely, while the rest of the world surprised on the downside, thereby dampening the outlook for rate hikes on those countries.
At the moment, that’s just not happening. In fact the four major economies are all pretty much hitting estimates – the UK a bit better than expected, the Eurozone not so much, but the deviation isn’t that great from a historical standpoint. So I think USD could be hitting its near-term peak for the time being.
In any event, we should get a lot more clarification about the Fed’s thinking next week. Nine of the 16 FOMC members are speaking next week, including two speeches by Fed Chair Powell (Tuesday and Wednesday). The speeches should deepen our understanding of what the members have in mind going forward.
Aside from these speeches, the major events of the week will be 1) the manufacturing purchasing managers’ indices (PMIs) on Monday, 2) the Reserve Bank of Australia (RBA) meeting on Tuesday, and 3) the ADP report and nonfarm payrolls, as usual on Wednesday and Friday.
The preliminary US and Eurozone manufacturing PMIs diverged notably: the US PMI rose, while both the German and French versions slowed notably. This is to be expected, as the EU PMI has fallen eight out of the last nine months. The possibility of a slowdown doesn’t seem to be discouraging ECB President Draghi however and should not dissuade the ECB from continuing to unwind its extraordinary stimulus program. Thus the divergence between the US and Eurozone may have less impact on the FX market than we might expect otherwise.
The key takeaway though is that with US manufacturing continuing to expand, the emerging market manufacturing PMI may manage to eke out a small gain as well, given the historical relationship between the two (the EM PMI tends to follow the US PMI more than the EU PMI, although both are statistically significant). We may see an improved result from several EM countries on Monday, which could bolster EM currencies.
Turning to the RBA meeting, the market doesn’t see even a 50% chance of a rate hike in Australia until next September at the earliest. There has been little change in the market’s view over the last month. Since the last meeting on 4 September, GDP rose faster than expected and employment gained more than expected, but this is not enough to warrant any change in the RBA’s view. I would expect this meeting to be pretty much of a non-event as far as the markets are concerned.
Accordingly, the US nonfarm payrolls (NFP) will be as usual the main event of the first week of the month. The NFP is expected to come in slightly higher than recent months at 185k (the six-month moving average of the initial figure is 177k), while the unemployment rate is forecast to fall a further 0.1 percentage point. This should all be bullish for the dollar.
On the other hand, the growth in average hourly earnings is forecast to slow somewhat. A slowdown in the growth of earnings could offset any impact of another solid gain in jobs and leave the market pretty much unaffected by the data.
Japan cash earnings, German factory orders and US trade also come out on Friday.
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