Not Quite Concluded

The question on lips that we see
Is four hikes more likely than three?
Could well be alluded
If not quite concluded
When next speaks the FOMC

Well, the big day is finally here and at 2:00 this afternoon the FOMC will release its latest monetary policy statement. Shortly thereafter, Chairman Powell will face the cameras in his first press conference as Fed chair. Here’s a recap of the situation as we await the news: at the December policy meeting the Fed raised rates 25bps, their fifth such rate hike since the process began two plus years ago, and penciled in three more rate hikes for 2018. However, in the intervening three months, US fiscal policy has been given a significant boost from both tax cuts and reform and a large increase in deficit spending. We have also seen US data perk up, specifically inflation data on wages, which has been a key lagging indicator for the Fed. Finally, we heard from Chairman Powell in his congressional testimony that in his personal view, things were definitely better in the economy. This series of events has led a large contingent of analysts to now expect the Fed to raise rates four times this year and perhaps again next year. Meanwhile, futures markets are pricing in a 39% probability of a fourth hike in 2018 and not even three hikes in 2019. This is where the rubber meets the road on my views for the dollar going forward. I continue to come down on the side that the Fed will be more hawkish than the market is pricing, and that as the market adjusts US rates higher, the dollar will benefit. But right now, it’s all speculation. We will find out this afternoon, and we can evaluate the situation tomorrow morning.

In the meantime, a look at the FX markets shows that after a very strong performance yesterday by the dollar, it is under pressure this morning. Yesterday’s movement seems to have been the result of positioning, or more accurately the unwinding of some of the massive short dollar positions that are extant. This morning, the most notable story has come from the UK, where the pound has rebounded sharply (+0.5%) after much better than expected UK employment data. The Unemployment rate in the UK fell to a lower than anticipated 4.3%, and the 3-month employment change rose by a much greater than expected 168K. The implication here is that the UK economy is going to weather Brexit far better than might be expected and that Governor Carney and the BOE are right to raise rates soon and begin addressing above target inflation. While I remain skeptical on the issue, if the data continues to show the UK economy improving, then I will have to change my view.

Elsewhere in the G10, the dollar is also lower, but there has been very little in the way of specific data or news to drive the movement. As I said before, this appears to be position adjustments ahead of the FOMC this afternoon.

In the EMG bloc, however, we are seeing some very substantial movement, notably MXN which has rallied more than 1% this morning on the back of the ongoing rebound in oil prices. Oil has reacted to heightening tensions between Saudi Arabia and Iran, collapsing Venezuelan production and increasing demand as evidenced by the surprising inventory drawdown in yesterday’s US data. This movement has helped not only the peso, but also RUB and CAD. The rest of EEMEA is generally firmer this morning as well, as this group continues to mirror the euro’s movements, but APAC currencies had a more mixed session, with both gainers and losers there. It seems that the dollar’s softness really started at the end of the Asian session, so is more developed in Europe. In the end, though, all of these currencies will be beholden to the FOMC’s actions this afternoon, so I wouldn’t get too caught up in the movement thus far.

And that’s really it for the day. At 10:00 we see Existing Home Sales (exp 5.42M) but it is hard to believe that the market will truly respond to that number today. Equity markets are little changed this morning after a bit of a whipsaw earlier this week with sharp declines Monday followed by a modest rebound yesterday. The 10-year yield continues to hover in its 2.85%-2.95% range, showing no signs of wanting to break out in either direction yet. However, one thing of note is the ongoing increase in 3mo LIBOR, which has hit 2.25%, its highest level since 2008. It seems that the increase in borrowing by the Treasury, which has largely been effected through short term Treasury Bills, and the conversion of much corporate cash to even shorter maturities as it is soon to be deployed (remember the repatriation story) has driven this market far more than had been anticipated. The knock-on effects here are that foreign USD borrowers are finding it more expensive to refinance their outstanding debt and thus we are seeing short-term rates rise in other countries around the world, notably those whose currencies are linked to the USD like Saudi Arabia and Hong Kong. Ultimately, this is all of a piece with the rising US rate story and I believe will continue to be supportive of the dollar going forward.

Until the Fed announcement, I find it hard to believe we will see much movement, but afterwards, be prepared for some fireworks. Funnily enough, I think the big risk to the market is that the statement and Powell’s comments are more dovish than expected. The hawkish view has clearly grown in stature lately, so I would guess the pain trade is a more dovish outcome (no indication of four rate hikes this year, no rise in the terminal rate), which would have an immediate negative effect on the dollar. I guess we’ll see in a few hours!

Good luck