Dollar Remains Soft Ahead of FOMC Decision

  • The FOMC meeting ends today and it is widely expected to hike rates 25 bp
  • Looking at the September Dot Plots, it would be easy to get a shift down from the three hikes currently signaled for 2019
  • It appears that the White House is backing away from its shutdown threat
  • The EU will reportedly hold off on starting excessive deficit procedures against Italy
  • UK November CPI was reported; Canada reports November CPI
  • Malaysia November CPI rose 0.2% y/y; Bank of Thailand hiked rates 25 bp to 1.75%, as expected

The dollar is broadly softer against the majors ahead of the FOMC decision.  Euro and Nokkie are outperforming, while Swissie and sterling are underperforming.  EM currencies are mostly firmer.  KRW and ZAR are outperforming, while MYR and MXN are underperforming.  MSCI Asia Pacific was up 0.3%, with the Nikkei falling 0.6%.  MSCI EM is up 0.5% so far today, with the Shanghai Composite falling 1.1%.  Euro Stoxx 600 is up 0.3% near midday, while US equity futures are pointing to a higher open.  The US 10-year yield is flat at 2.81%.  Commodity prices are narrowly mixed, with Brent oil flat, copper up 0.3%, and gold down 0.1%.

The FOMC meeting ends today and it is widely expected to hike rates 25 bp.  The new range for the Fed Funds rate would be 2.25-2.50%.  Markets will be more interested in what the Fed sees for 2019 and 2020.  In that regard, it seems likely that the Dot Plots will tilt slightly more dovish.  However, we do not think the FOMC statement will veer much from recent Fed communications that suggest a more data-dependent path ahead.

Looking at the September Dot Plots, it would be easy to get a shift down from the three hikes currently signaled for 2019.  If two members move their end-2019 rate from 3.125% to 2.875%, the median would likewise drop 25 bp to 2.875%.  Nor would it be hard to see a shift down the longer-term neutral rate, which is currently at 3%.  If only one member moves from 3% to 2.75%, the median would drop 25 bp to 2.75%.

While there may be a dovish shift in the Dot Plots, we do not think the Fed statement will veer much more dovish.  Previous comments from Clarida and Powell have already done the heavy lifting with regards to messaging, and we do not think the Fed wants to become characterized as becoming even more dovish.  There will likely be a slight tweak in the language that suggests more data dependency in 2019.

If this comes to pass, it would be characterized as a dovish hike.  The dollar would likely soften, and equities would likely catch a bid.  Yet we continue to believe that markets are misreading the current macro backdrop.  The US economy remains firm in Q4 and we downplay the near-term risks of recession.

Ahead of the decision, the implied yield on the January 2020 Fed Funds futures contract is trading around 2.51%.  This is the lowest since May 31 and strikes us as way too dovish.  With effective Fed Funds currently around 2.20%, this means that markets are only pricing in a very small chance of one hike in 2019, assuming that the Fed hikes 25 bp today.  The Fed Funds futures strip has also started pricing in a potential cut in 2020.

It appears that the White House is backing away from its shutdown threat.  The demand for $5 bln in funding for the wall has reportedly been dropped but the Democrats have rejected a new offer from the GOP that would funnel an extra $1 bln of unspent funds towards implementing Trump’s immigration policies.  A deal needs to be reached before the deadline of midnight Friday.  One likely scenario is that a short-term funding extension will be passed, handing the responsibility of finding a longer-term solution to the incoming Democratic House.

The EU will reportedly hold off on starting excessive deficit procedures against Italy.  Reports suggest that the two sides have accepted Italy’s compromise deficit equal to -2.04% of GDP next year.  EU officials noted, however, that the solution is not ideal and that the budget still raises concerns.  However, it’s clear that both sides made some compromises in order to avoid roiling the markets.  Now, if only France would get the memo.

The news has helped the euro move above the $1.14 area.  The $1.1450 area should provide some resistance but if we get a dovish hold from the Fed today, we could easily go on to test the $1.15 area.

UK November CPI was reported.  Headline inflation eased a tick to 2.3% y/y, as expected.  However, CPIH was steady at 2.2% y/y instead of an expected drop to 2.1% y/y.  November retail sales will be reported tomorrow before the BOE decision is announced.  At this point, the macro data really have no implications for monetary policy.  Until Brexit has been cleared up one way or another, the BOE is simply stuck in a wait and see mode.

Canada reports November CPI.  Headline is expected to ease to 1.8% y/y from 2.4% in October, while core common is expected to remain steady at 1.9% y/y.  The next Bank of Canada meeting is January 9 and expectations are for another 25 bp hike to 2.0%.  The last 25 bp hike was in October but we see a rising chance of a dovish surprise next month.  Much will depend on how oil prices are trading then.

CAD has been underperforming due to plunging oil prices, weakening to test the 1.35 yesterday before stabilizing.  The Loonie is at its weakest level since June 2017 and USD/CAD is on track to test the May 2017 high near 1.3795.

Malaysia November CPI rose 0.2% y/y vs. 0.4% expected and 0.6% in October.  This matches the cycle low from August.  While Bank Negara does not have an explicit inflation target, low price pressures should allow it to remain on hold through much of next year.

Bank of Thailand hiked rates 25 bp to 1.75%, as expected.  The vote was 5-2, with the dissenters favoring steady rates.  This was the first hike since 2011.  The bank cut its 2018 and 2019 growth forecasts to 4.2% and 4.0%, respectively.  Its inflation forecast for 2018 was kept steady at 1.1% whilst its 2019 forecast was cut to 1.0%, both at the bottom of the 1-4% target range.  As such, we expect a very shallow tightening cycle ahead.