The Federal Open Market Committee is widely expected to raise interest rates for the third time this year and for the fifth time since the end of 2015 on Wednesday. But what seems to matter the most to investors regarding the outcome of the meeting, is the update on the country’s economic outlook and the speed of the delivery of stimulus reduction in the upcoming years. However, investors are already having doubts on future rate increases as recent data on average earnings surprised to the downside.
According to the CME FedWatch tool, markets have already priced in an interest rate hike by the end of the two-day meeting by the Federal Reserve on Wednesday. In November, policymakers had acknowledged the strength of the US economy, saying that the labour market “will somewhat strengthen further” pushing inflation higher towards the Fed’s target of 2.0%, while the next Fed chief, Jerome Powell, argued during his confirmation hearing that “conditions are supportive” for another rate hike in December.
In the June forecasts, policymakers projected three more rate hikes in 2018. However, in the September projections, although FOMC members were more optimistic about the growth outlook in 2018, the persistent soft patch in inflation has kept rate-setters more cautious about the speed of further monetary tightening. Besides that, November’s nonfarm payrolls report indicated that average earnings react little even if the economy operates near full-employment conditions, with the unemployment rate currently standing at 17-year lows.
Potential tax cuts promised by Republicans could also bring some headache to the Fed as Republicans would likely pressure policymakers to avoid faster rate increases as those would offset benefits from their tax legislation. Still, Fed officials have so far avoided taking any position over the tax cuts, with Powell recently expressing that the central bank will not seek to forecast the impact of tax reforms until this turns into law.
Since a rate hike is priced in by the markets, the financial statement and Fed chair Janet Yellen’s last press conference (as her term expires in February) following the rate decision are anticipated to be the main market movers. The dollar is currently consolidating gains around the 113 key-level, but the bullish short-term picture remains in place as the RSI is still above 50 and the bullish cross between the moving average lines is still intact. Optimistic statements from FOMC members could push the pair towards the nine-month high of 114.72. In the alternative scenario, a dovish take might drive the pair down to meet the area around the 112 and 111 key levels.
Wednesday will also see the release of US CPI figures for the month of November (1330 GMT). The headline index is expected to rise by 0.2 percentage points relative to the preceding month’s pace to 2.2% y/y in November, while the core measure which excludes volatile items is anticipated to stand flat at 1.8% y/y. Note that the Fed compares its inflation target of 2.0% with the core PCE index instead and adjusts its monetary strategy accordingly, as this includes a wider range of consumer products.
