The bigger the crack, the stronger the dollar. Oh, a rate hike now in September? The chances are extremely small. Nevertheless, the lack of a rate hike does not mean markets will not move. It’s a big event.
This Fed decision is accompanied by updated forecasts as well as a press conference by Yellen. The hype means tension ahead of the release on Wednesday at 18:00 GMT and quite a few sessions of higher volatility following the publication.
3 reasons NOT to hike
Here are three quick reasons why the Fed will NOT raise rates. Needless to say, a surprising hike will trigger a massive dollar rally. But yet again, this will not happen:
- Elections are coming: The Fed cherishes its independence, but to maintain it, staying off the political radar in a politically charged time is essential. Trump likes low rates and dislikes Yellen. Clinton, seen as the incumbent, will not like to see the stock market fall ahead of the vote. This is especially true as the race is basically tied.
- The Fed is dovish: When in doubt, stay out, seems to be the motive of the Fed. They do want markets to take them seriously, that every meeting is “live” and that everything can happen, but they only make a hawkish move when they are 200% confidence. Yellen said the “case for a rate hike is increasing” but that was no smoking gun. Brainard, seen as going hawkish and providing that smoking gun, provided the last nail in the hike coffin, with her last minute appearance.
- The data: Employment has recovered from the Spring blip, but wages are going backwards, rising at a slower pace. Inflation is not going anywhere fast, and growth has markedly slowed down, with 3 quarters of ~1% growth: Q4 2015, Q1 2016 and Q2 2015. The most top-tier data was mediocre at best: retail sales slumped, consumer confidence did not budge, and the services sector PMI is at its worst since January 2010. Growth forecasts for Q3, supposedly the comeback quarter are trimmed down with each release. There is just no evidence that the economy is heating up or that it is about to heat up.
If three reasons aren’t enough, here are 10 Reasons Why The Fed Will Not Hike This Year by Danske
Forecast focus
The Federal Open Markets Committee convenes eight times a year but accompanies these meetings with forecasts and a press conference only four times a year. This is one of them. The Fed publishes forecasts for growth, employment and inflation. This time, the outlook reaches all the way to 2019. Estimations have been rosier than reality in too many cases. Also, they are not expected to change too much this time.
This pushes the focus to the dot-plot: the estimation of where rates will be in the future. With only two meetings left in 2016, the immediate focus will be on the 2016 outlook. It is safe to assume that two rate hikes are off the cards, at least for the vast majority of members. The bigger question is binary: 1 hike or no hikes?
It is likely that the Fed will leave the option of a hike on the cards, with the majority seeing one more hike. This will be acknowledging reality but also serve as a reassurance that the next move of the Fed is to hike rates. It also makes sense to hike in December, after the elections and also as more positive employment and perhaps positive growth data emerge.
An open door to a December hike will strengthen the dollar, which will maintain its role as the “cleanest shirt in a dirty pile”.
In case the Fed removes the forecast for higher rates this year, the greenback will likely plunge.
After the immediate reaction, it will also be interesting to see the forecast for 2017 as well as the long-term rates. If these are significantly downgraded in comparison to the June projections, it could hurt the dollar, but changes are likely to be in line with the decline for 2016: acknowledging reality and nothing else.
The Statement
In meetings that don’t consist of forecasts, we only have the statement. Nevertheless, it is of high importance also now. Yellen and her colleagues are likely to remain content about employment and could also be more relaxed on international developments, perhaps like in July.
The bigger questions are how they see inflation and growth. Both are not going anywhere fast. The Fed has seen long-term inflation expectations as stable. Will they drop this line now? It could hurt the dollar if they express worries. So far, the US avoided a European or Japanese style flirt with deflation, but nothing last forever.
On growth, expressing worries could hurt the greenback but they could as well leave the commentary unchanged, yet again, supporting the “cleanest shirt” narrative.
Yellen’s press conference and the big aftershocks
Fed Chair Janet Yellen will make the case for the decision and then attend to questions for about an hour, starting at 18:30 GMT. Yellen has mastered the art of her predecessors, talking and talking without saying anything to rock the boat. It is hard to believe we will get anything meaningful. Yellen tends to be dovish, but we all know that.
Her words will be closely watched, and markets may move while she speaks, but not necessarily on what she says. At the same time, Fed watchers such as Jon Hilsenrath at the WSJ and others will begin explaining the Fed. We will get comments from influential banks such as Goldman Sachs and closely watched market movers such as Bill Gross. Their analysis of the Fed’s statement and data will begin streaming in and affect markets.
These aftershocks could come in waves: an immediate reaction, a second reaction when Tokyo opens and a third reaction in the European open, once narrative has formed.
As always, this event could result in high volatility, which in itself calls for lower leverage. Trade with care.
More: Why the FOMC Won’t Hugely Change The Big Picture For USD – BTMU