‘Dovish Fed Rate Hike' is what the market expects

The ‘Dovish Fed Rate Hike’ is what the entire market is preparing for.
by Ipek Ozkardeskaya

From corner to corner, there is more of a position adjustment going on, with investors mostly worried about unwinding positions and decreasing exposure rather than about building fresh position as the visibility is low when the volatility is expected to be high.

The promising November inflation released in the US yesterday, rolled the red carpet leading to the first 25 basis point raise.

The Fed will certainly temper the hawkishness of the rate tightening by a fairly dovish accompanying statement. As the first Fed rate hike is mostly factored in, the outlook apropos the steadfastness of the policy tightening is yet to be priced in. The larger perspective on the Fed policy is likely to bring the Fed dots under the spotlight over the next few weeks.

The rate hike expectations range from one additional rate hike to follow in 2016 to four consecutive hikes anticipated by the most hawkish analysts at the moment. The truth is that more data points, from the US and abroad, are needed to come up with a long-term view.

The pace of US policy normalisation will certainly be contingent to the macroeconomic data, as it has been the case until today.

Downside risk in the US Dollar

The latest CFTC data shows that the market has been relentlessly building on the non-commercial USD long positions since mid-October. This could mean that a less hawkish perception of the Fed could well trigger a long squeeze and send the US dollar lower despite a rate hike. In the same fashion that a rate cut triggered a rally in the euro two weeks ago.

As the short-term volatility is two-sided, the mid/long-term view remains anchored on the upside concerning the US dollar. The divergence between the Fed and the ECB policy outlook is deepening, although the policy differential happens in a softer-than-expected hustle.

Euro bulls have temporarily abandoned the idea of breaking the key 1.1080 handle before the Fed decision. In the short-run, the 1.0855 (major 38.2% on post-Draghi raise) is a pivotal level. Above this level, the short-term technical bias is expected to remain on the upside for a re-test of 1.1080/1.1120 region (Fib 50% on Aug-Dec slide). Surpassing the 1.1120 could pave the way for an advance to the mid-term critical technical resistance of 1.1260 (major Fib 61.8%).

BoC’s Poloz and BoE ‘s Carney made clear their intent to stay clear of the policy tightening. Nevertheless, the history shows that the UK may not stay too far behind the Fed in this adventure and could well fire the engine within the next six months. The market assess 25% chance for a May action from the BoE, while in contrary, Canada is given 35% chance for a 25 basis point cut in the first half of 2016.

Sterling tests $1.50
by Brenda Kelly

While the FOMC decision is the main event today, we have a number of important sideshows taking place. The Eurozone economy has certainly started to look perkier with a solid end to the year and PMI readings remaining above the key 50 level. France continues to trail Germany with businesses there reporting a weak increase in activity and employment levels.

The pound has staged a decline against the euro and the dollar this week – touching on a seven week low against the single currency yesterday.

Sterling weakness comes in part on the back of a rather dovish Mark Carney who has stated that conditions to hike interest rates are still not evident. The fact that average earnings increased by 2.4% in the year to October, 0.6% down on the previous month and lower than consensus is now putting additional pressure on the pound which is oscillating around the $1.50 level again.
Unemployment did fall by 110,000 between August and October to 1.71m and the unemployment rate is now at 5.2% but it would seem that the BOE wishes to lag the FOMC as has been the historic case in terms of monetary tightening

Oil prices continue to chop around and now that the 40 year ban on US exports has been lifted the supply glue issue seems to be here to stay – this may create additional downside in oil and gas stocks in the medium term.

In UK equities, Vodafone is adding the most points to the FTSE this morning as the talks between it and cable TV operator Liberty regarding an asset swap may not actually be complete. The valuation gap was the reason that talks ended back in late September and now that Vodafone has risen strongly off its lows of close to 200p any sustained move higher could re-ignite discussions. Shares are up 1.8% presently.

Risk appetite today seems to be excluding the mining sector as we head towards the Fed rate decision later this evening. Nevertheless the fact that price action is above the 6030 level does tend to set us up for additional gains and the prospect of the Santa Rally, excluding the outside chance of a hawkish Fed seems like a distinct possibility.

Other equity highlights:

Dixons Carphone (+3.31%) UK and Ireland LFL sales up 4% better than the 1.5% expected. A strong Black Friday helped it win market share. Pretax profit of £78m for the 26 weeks to October 31.

John Wood Group (+1.2%) Gets main contractor framework agreement worth ~$400m to deliver maintenance, modification services to four Statoil installations on the Norwegian continental shelf

Tesco (-2.34%) All supermarkets giving back some of yesterday’s gains following the Kantar survey. Morrisons (-1.16%) Sainsbury (-1.64%)

BT Group (-0.76%) Cut to sell v hold at Deutsche Bank.