Fed Preview: Dollar-friendly dot-plot before a Powell punishment?

The first rate decision by Federal Reserve Chair Jerome Powell makes it more important than his next ones. It is not due to the rate itself: Powell will raise the interest rate from a range of 1.25%-1.50% to 1.50%-1.75% in his first FOMC meeting heading the Fed. That has been well-telegraphed by the central bank.

First course - the dot-plot

The announcement is due on Wednesday, March 21st at 18:00 GMT and will be accompanied by the regular statement and more importantly, the Fed's forecasts. This will be the first market mover.

All FOMC members, voting and non-voting, cast their forecasts for growth, inflation, employment, and the path of interest rates. The latter publication, also known as the dot-plot, sends markets a message about the path of rates going forward. In the last report published in December, the Fed pointed to three hikes in 2018.

The big question is: will they raise it four hikes this year? 

Markets are slightly leaning towards an upgrade to four, but are not 100% sure and nothing is 100% priced in. An upgrade would boost the US Dollar while staying put at three would weaken it.

In his testimony before Congress on February 27th, Powell said that a few things have changed since the Fed last published the dot-plot in December. He listed positive developments: tax cuts, fiscal spending, higher inflation and higher wages. With this answer, Powell hinted an upgrade of the dot-plot to four hikes.

However, since then, wages decelerated from 2.9% YoY to 2.6% YoY in February's report, and the monthly gain was only 0.1%. Inflation is not going fast either: Core CPI is stuck at 1.8% YoY and also here, monthly Core CPI is slower: 0.2% against 0.3% beforehand. 

Given these changes, will the Fed leave the dot-plot at three hikes?

The answer is probably not. The FOMC is comprised of Governors who are permanent voters and regional Fed Presidents. These Presidents tend to be more hawkish than the Governors. In the rate decision, not all Presidents have a vote: they rotate every year. Also, they all sit in a room and most voting members vote with the Fed Chair. 

Yet with the dot-plot, all FOMC members submit their projections with less pressure from the Fed Chair. This means that the more hawkish members have more say.

In previous events, markets reacted first to the dot-plot. If it indeed indicates four hikes 2018, the US Dollar might rise in the initial, knee-jerk reaction. The accompanying statement may be more moderate, but the focus tends to be on the dots.

Afterward, markets will have half an hour to sift through everything: the exact wording of the statement, the change in the dot-plot for 2019, the final interest rate, and the forecasts. We could see some profit taking after the initial move especially if the other figures are more moderate.

Second course - Powell's presser

At 18:30 GMT, the Chair will face reporters for his first post-rate decision press conference. He will first explain the decision and will likely express confidence. A central bank cannot raise interest rates without reasoning it without the underlying message that the economy is doing well. The recent rise in jobs, 313,000 in February, is an excellent source of confidence. Full employment is one of the Fed's mandates, and the world's No. 1 economy is getting closer to this status.

Later on, he may opt for a more nuanced tone. He will inevitably be asked about the dot-plot and may stress that it is not a commitment but rather a reflection of the views of the various members. By not attaching himself personally to four hikes, Powell may release some of the hot air out of the greenback.

And there are good reasons to be skeptical, especially about the Fed's second mandate, inflation:

1) Wage growth: Powell has already expressed a more cautious approach to wages in his testimony. The setback to 2.6% YoY means that the Fed needs to wait and see.

2) Inflation: The Fed focuses on the Core PCE figure which is released only at the end of the month. However, it closely tracks the Core CPI, which is not going anywhere fast.

3) Growth: The US enjoyed robust 3.0%+ annualized growth in Q2 2017 and also Q3 2017. The figures for Q4 are already below this level, at 2.5%, back to the old normal, according to the second release. More worryingly, indicators for Q1 2018 are a source of concern: retail sales disappointed over and over again and the Atlanta Fed's GDPNow points to a growth rate of only 1.9% in this quarter. The Fed can blame it on the weather but will likely prefer being more cautious. 

4) Trade: Since Powell's testimonies at the turn of the month, Trump announced his tariffs on steel and aluminum, sparking fears of a trade war. Journalists will undoubtedly ask about the topic and Powell; an experienced lawyer will likely stay away from making overtly political statements. Nevertheless, he may indicate that uncertainty about the future of trade is a risk to the economy that the Fed may have to factor in. Anything along these lines may weigh.

Dessert - Market reaction

Markets will respond to the first and second parts, and when Powell wraps up, around 19:30 GMT, they will have plenty of time to fully digest everything and construct a wider narrative. Analysis from pundits, journalists, and keen Fed watchers will have their say.

An additional significant move will come at the Tokyo open, and another response will be seen in the European open on Thursday.

If this analysis is correct, the US Dollar will first rise and then fall, creating an opportunity. Needless to say, there are many additional scenarios.

• Dovish: Leaving the dot-plot at three hikes will weigh on the greenback no matter what.
• Very hawkish dot-plot: Raising the dot-lot to four hikes in 2018 and also raising the forecasts for 2019 and the final rate will send the US Dollar higher in a stronger initial move, before Powell talks.
• Hawkish Powell: A dot-plot upgrade and a much more hawkish Powell that indicates an overheating of the economy will likely trigger a second wave of US Dollar buying.
• Very dovish: Leaving the dot-lot unchanged and grave worries from Powell about the future of trade and/or fears of a recession will likely trigger two waves of US Dollar selling. 

All these scenarios are possible but have a lower probability given everything explained beforehand. 

Here are additional opinions:

• Dovish: Fed still aims for three hikes in 2018 – UOB
• Hawkish: Fed’s Door Ajar for Four Fed hikes
• Very hawkish: Fed likely to hike rates five times in 2018 – Deutsche Bank