Dollar Mixed Ahead of FOMC Decision

Dollar Mixed Ahead of FOMC Decision

It’s all about the Fed today and we share our thoughts what to expect this afternoon.  In other areas of the world:

  • UK reported soft August retail sales
  • Japan reported August trad
  • Before the FOMC decision comes out, the US will report a fair amount of data
  • Poland reports August industrial output, PPI, and retail sales
  • Bank Indonesia met and kept rates steady at 7.5%, as expected

Price action:  The dollar is narrowly mixed ahead of the FOMC decision today.  The euro is outperforming, while the dollar bloc is underperforming.  The euro is trading back above $1.13 after testing the 200-day MA yesterday near $1.1235, while cable is trading just above $1.55 despite softer UK retail sales data.  Dollar/yen is moving higher, testing the 200-day MA near 120.85.  EM currencies are mixed.  KRW, THB, and PHP are outperforming while TRY, ZAR, and RUB are underperforming.  MSCI Asia Pacific was up 0.8%, with the Nikkei rising 1.4%.  Chinese markets fell, with the Shanghai Composite down 2.1% and the Shenzen Composite down 1.5%.  Euro Stoxx 600 is down 0.1% near midday, while S&P futures are pointing to a higher open.  The US 10-year yield is down 2 bp to 2.28%, while European bond markets are mostly firmer.  Commodity prices are mostly lower, with oil prices down nearly 1.5%.  Copper prices are up slightly in the wake of the Chilean earthquake.

  • It’s all about the Fed today.  The decision will be released at 2PM EST, followed by Yellen’s press conference at 2:30PM EST.  It will be a very close call.
  • If the Fed hikes the Fed funds target range, we expect Yellen’s press conference to emphasize the gradual pace it anticipates.  The dot plots will likely point in that direction too.  Fed officials will likely give up on the idea of two rate hikes this year, and by doing so, lower the projections for the appropriate Fed funds target for next 2016 (and probably 2017 too, even if by a lesser extent).
  • If the Fed does not hike rates today, Yellen’s press conference may take on a somewhat more hawkish bent.  The door to a hike this year will be kept wide open.  We have argued that the Fed ought to have a press conference after every meeting, like the ECB and BOJ.  This would avoid the operational challenge to calling an impromptu press conference to explain a rate hike, such as in October.  There is a small chance that Yellen pre-announces a press conference for next month’s meeting.  That would also send the message that a hike foregone today may still be delivered shortly.
  • Counter-intuitively, a decision to hike rates could spur a relief rally.  They did it.  It is behind us.  It would not be surprising to see risk assets, such as equities and emerging markets to rally.  The dollar would ease in such a scenario.  The hike is out of the way.  The Sword of Damocles no longer hangs over the market.  The uncertainty over Fed policy would be resolved.  It would be out of the way.  US monetary policy setting would still be highly accommodative.
  • If the Fed does not hike today but provides guidance to expect a hike later this year, the uncertainty would not be lifted sufficiently.  Risk assets could fall, and the dollar could strengthen.  A couple of years ago, a Polish foreign minister quipped that German inaction scares him more than German action.  In a similar vein, we suspect that Fed inaction would be more destabilizing than Fed action at this juncture.
  • Before the FOMC decision comes out, the US will report a fair amount of data.  These include Q2 current account (-$111.5 bln consensus), August housing starts (-3.8% m/m consensus) and building permits (+2.5% m/m consensus), weekly initial jobless claims (275k consensus for the NFP survey week), benchmark revisions to employment data, and the Philly Fed index (5.9 consensus).
  • UK reported soft August retail sales.  Headline sales rose 3.7% y/y vs. 3.8% expected, while sales ex-auto fuel rose 3.5% y/y vs. 3.8% consensus.  July readings were revised down for both series.  This week’s data was mixed but still on the firm side.  Inflation readings were low and jobs data was strong.  All in all, the data have fit into the narrative of a BOE tightening cycle in the months ahead, but we do not see this happening until 2016
  • Japan reported August trade.  The adjusted balance came in at –JPY359 bln vs. –JPY377 bln expected.  Exports rose 3.1% y/y vs. 4.3% expected, while imports contracted -3.1% y/y vs. -2.5% expected.  The yen may resume its weakening trend as we move into Q4, when many expect further BOJ easing measures in light of the weakening Japanese economy.  Near-term, the yen will be driven by the Fed.
  • New Zealand GDP growth came in weaker than expected.  Q2 growth was 2.4% y/y vs. 2.5% expected and a revised 2.7% (was 2.6%) in Q1.  Softer data may feed expectations that the RBNZ still has a couple more rate cuts in the pipeline.  Next meeting is October 30, and a 25 bp cut to 2.5% is expected.  Many observers had thought that 2.5% was the likely floor for rates, but dovish language from the RBNZ after the last 25 bp cut earlier this month left the door wide open for further cuts.
  • Chile was struck by an 8.3 magnitude earthquake late last night.  A tsunami warning was issued as well, and copper prices were initially bid.  However, state-owned copper company Codelco later said that none of its facilities were damaged by the quake.
  • Poland reports August industrial output (6.4% y/y consensus), PPI (-2.4% y/y consensus), and retail sales (1.5% y/y consensus).  The central bank will also release minutes from its last meeting.  Despite the robust recovery, Poland still faces deflationary risks and so the central bank is likely to keep rates low until at least mid-2016.
  • Bank Indonesia met and kept rates steady at 7.5%, as expected.  CPI rose 7.2% y/y in August, well above the 3-5% target range.  BI has been on hold since February, when it cut rates 25 bp to 7.5%.  We think it is likely to remain on hold until price pressures abate, especially in light of continued weakness in the rupiah.