The Fed Rate Hike Awakens After Long Prelude

After First US Interest Rate Hike in a Decade Focus Will Shift to Monetary Policy Pace Next Year

This week in the foreign exchange market was always going to be about the December Federal Open Market Committee (FOMC) meeting. The spectacular failure to communicate with markets shown by the European Central Bank (ECB) at the beginning of the month, has heightened anxiety on such an awaited event. The taper tantrum in the summer of 2013 caused a similar disconnect between Fed rhetoric and market expectations. The Fed has been able to manage its communications better, but given the example of the ECB statement aftermath the market is sensitive to miscommunication risk that could bring volatile trading conditions.

The Fed has talked itself into a corner starting in that summer of 2013. Even though it tried to convince the market that “tapering was not tightening” it started to have that effect on currency prices. At the end of the quantitive easing program, the timing of the first rate hike dominated the market chatter. The Fed made it a question of “when” and not “if” there was to be higher benchmark rates in the U.S. the economic recovery kept losing steam in 2015 and the macro picture started to degrade as well but the Fed renewed its commitment to raising rates. The Fed will release its FOMC statement on Wednesday, December 16 at 2:00 pm EST. A press conference with Chair Janet Yellen will follow at 2:30 pm EST.

The EUR/USD has appreciated 3.3 percent after the ECB fell short of market expectations on December 3. EUR shorts had crowded the market and by delivering less of a commitment to stimulus than was anticipated given the rhetoric of ECB President Mario Draghi that trade was quickly unwound and the pair reached 1.10 as a reaction. As the FOMC date has crept closer the USD has slowly regained some of the losses, but still trades higher than before the ECB announcement. At time of writing the EUR/USD traded at 1.0930.

The U.S. Federal Reserve has teased the arrival of higher interest rates for almost two years. The end of quantitative easing that came with a slow tapering process was reached at the end of 2014 and for a whole year every FOMC the market has weighed the probability of a rate hike. The Fed shifted from the transparency of forward guidance towards the uncertainty of data dependency. The June and September meetings were heavy favoured candidates but now after a sentence in the October statement the market is awaiting the announcement and the rate to be < 0.50 percent.

The knowledge that the Fed was going to hike rates has already been priced in given the long preamble, investors are warned about volatile price action following the announcement, specially given the situation after the ECB meeting has further sparked uncertainty on market reactions on heavily anticipated events.

USD events to watch this week:

Wednesday, December 16

8:30 am USD Building Permits

2:00 pm USD FOMC Economic Projections

2:00 pm USD FOMC Statement

2:00 pm USD Federal Funds Rate

2:30 pm USD FOMC Press Conference

Thursday, December 17

8:30 am USD Philly Fed Manufacturing Index

8:30 am USD Unemployment Claims

*All times EST