Sat, Nov 27, 2021 @ 21:28 GMT
HomeContributorsFundamental AnalysisFOMC Preview: No Rate Hike Expected, But Hawkish Fed Likely

FOMC Preview: No Rate Hike Expected, But Hawkish Fed Likely

After the Federal Reserve’s latest interest rate hike in March, the first this year, market expectation for further hikes in 2018 remained steady at two more – one in June and one in September. Since March, however, market speculation on yet another hike, to make four in total, has risen. Currently, the federal funds futures market is pricing-in the probability of an additional December rate hike at around even, but slightly skewed towards the positive.

This Wednesday afternoon brings the conclusion of the Fed’s latest FOMC meeting, along with its policy decision and statement. No press conference will be held this time around, nor will there be any formal economic projections. In addition, no interest rate hike is expected. Then why, one may ask, will this particular FOMC event be of much consequence? Markets and investors will be laser-focused on the Fed’s statement primarily to glean any clues as to whether the central bank’s tightening trajectory may indeed be accelerated.

In the run-up to Wednesday’s decision and statement, US government bond yields have stayed elevated, with the benchmark 10-year Treasury yield remaining not far below the key 3% mark that was recently breached to the upside. Increased expectations of higher interest rates as reflected in bond yields have helped to boost the US dollar dramatically in the past two weeks, swiftly pulling the greenback out of its previous slump. At the same time, equity markets have been pressured by a higher rate outlook, despite what has generally turned out to be a very positive earnings season thus far.

These higher interest rate expectations stem from a few key fundamental factors that are likely to compel a more hawkish Fed on Wednesday. Consumer and business confidence have risen lately, as have wages and the overall employment landscape, and the outlook for US economic growth remains substantially optimistic. The positive impact of fiscal stimulus in the form of tax cuts has yet to be determined, but will likely serve as a tailwind for the economy going forward. As for inflation, most widely followed measures, including both the CPI (headline and core) and PCE (headline and core) show that consumer inflation is at or near the Fed’s oft-mentioned 2% target. And while US trade protectionism along with the resulting threats of global trade wars could have some bearing on the Fed’s monetary policy trajectory going forward, US trade policy (most notably with regard to China, Europe, and NAFTA partners) is far from solidified, and will therefore unlikely make much of a substantial impact on current Fed discussions.

As the Fed on Wednesday is most likely to deliver an unchanged monetary policy along with a hawkish statement, the real question may be, how hawkish? Any discussion or rhetoric change in the policy statement that suggests a potentially increased outlook for inflation and/or economic growth, or otherwise hints at the possible need to pick up the pace of tightening, could have the effect of extending the dollar rally while placing further pressure on equity markets. In contrast, if the Fed is less hawkish than might be expected, the dollar rally could take a breather while stocks might be given some room to recover from the volatility and losses of the past three months.

Forex.com
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