US Inflation, Floyd Mayweather and the FOMC

What has all the hype of a Mayweather fight but doesn’t involve booze, celebrities and ringside seats? The Fed rates decision, that’s what! The time has finally arrived for the FOMC to reveal their game. On Wednesday at 2pm EST (early Thursday morning AEST), the Fed will be releasing its much anticipated rates decision, followed by a Press Conference by Fed Chair Janet Yellen at 2:30pm EST.

The biggest shock would come of course if the Fed holds rates – but market participants are pretty much discounting this scenario in favour of a 25bp rise to 0.50%.  So unless Yellen & co cause a huge upset by not increasing rates, the post-decision statement and conference is where the money is won and lost. Expect the language in the statement to be non-controversial with adjectives like gradual, measured and careful with respective to further tightening natives. Likewise, Fed Chair Yellen is going to try and keep things low-key in her post-decision address.

Perhaps even the distribution of votes in favour of a rate increase may give markets the perception of the likelihood of subsequent rates hikes, with Fed Governors Brainard and Tarullo – both voting members – haven’t exactly been enthusiastic about rate increase any time soon.

“I wouldn’t expect it would be appropriate to raise rates” Tarullo said in an October interview on if rates should be increased this year.

Any change in inflation expectations may also be a market moving thematic in the ensuing period. With the Fed’s preferred measure of inflation still running below the 2% target, one would expect any change in expectations (upward revision) may be taken as a signal the Fed may increase rates at a faster pace than originally anticipated.

Overnight we saw the headline inflation rate unchanged in November, representing yearly growth of 0.5%. Taking out the more volatile food and energy (Core inflation) rose 0.2% on month, or 2% YoY. The Fed’s preferred measure of inflation is the personal consumption expenditure (PCE) index which rose 1.3 over the year until October.

Tracking US inflation (PCE) over 10-years

So what do the big boys saying about the dollars fortunes surrounding the FOMC?  Morgan Stanley likes the risk to reward ratio of being long greenback heading into meeting, but it of course depends on how you express it. In a note via eFX news, the bank says a “combination of weak commodities, stress in high yield and uncertainty about China’s FX policy may lead funding currencies to outperform. The deterioration in risk sentiment is supporting our bullish JPY call, and EUR’s negative correlation to risky assets is strong, especially given the disappointing ECB announcement earlier this month.”

Should the Fed’s messaging fail or broader macro concerns weigh on risky assets, the USD is actually vulnerable against EUR, JPY and other non-commodity G10 currencies. Therefore we prefer to play USD longs against AUD and CAD in G10 and select EM currencies such as TRY and BRL.