Week Ahead in FX: Fed to End Record Low Interest Rates

All Eyes on the Fed as First Rate Hike in Decade Expected

December of this year was never going to be a quiet affair. Central banks shackled market volatility for years and when it was time to let go; it was bound to give way to a more uncertain trading environment. The European Central Bank (ECB) was the first monetary policy divergence event scheduled on the last month of the year. The communication of the central banks intentions via the comments from President Mario Draghi turned out to be poor. The market was expecting a strong show of force and full commitment to quantitative easing. A bold request? Maybe, but Mr. Draghi had used similar language to that used during the Greek Crisis. Strong words built anticipation for strong actions. The ECB did not follow through failing to significantly add to its amount of bond purchases and it later blamed the market on misunderstanding when it did enough, but the reality is that it did not fully commit.

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 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 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.

The Fed Awakens Before the End of the Year

This week in the foreign exchange market was always going to be about the Federal Open Market Committee (FOMC) meeting. The spectacular failure to communicate with markets shown by the 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 miscommunication can still happen with catastrophic consequences.

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 and 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. Yet the Fed had committed to raising rates.

Chair Yellen was the responsible for communication of the start of tapering back in 2014, when Ben Bernanke was Chair of the Federal Reserve. It remains to be seen if the lessons of transparency were learned, or if the central bank prefers the obfuscation of using a blind devotion to economic data to guide monetary policy.

USD events to watch this week:

Tuesday, December 15
8:30 am USD CPI m/m
8:30 am USD Core CPI m/m
11:45 am CAD BOC Gov Poloz Speaks
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

Bank of Japan Not Expected to Ease but JPY Reaching Halloween Levels

The Bank of Japan under the leadership of Governor Haruhiko Kuroda was the most proactive central bank in 2013, it disappointed in 2014 for its lack of action until October 31 when it launched an expansion to its QE program. In 2015 there was heavy anticipation that the BOJ would again expand its bond purchasing program to boost the economy, but so far October and the preferred November meetings came and went. Given the uncertainty at the end of the year it would be rare for the central bank to modify its stance, then again they did something like this in 2014 with the shock announcement.

The monetary stimulus and the full Abenomics initiative has faced stronger than estimated headwinds from macro conditions. Slower growth in China and the deflationary effect of lower energy prices to an importing nation have made the 2 percent inflation target so famously set by Prime Minister Shinzo Abe, unattainable in the original timeline. But not all is lost, as the aggressive QE program has sparked inflation. The problem from Japan lies in corporate spending, or lack of. Corporates have used low rates to boost productivity, but have not raised wages or spent. Abe has tried everything under the sun, from asking nicely to now urging unions to demand higher wages from employers. Consumers will only be convinced to spend if higher wages are commonplace and a virtuos cycle can be kickstarted by Shinzo Abe’s government.

Given the backlash after the ECB decision the BOJ was seen to be monitoring the price of the USD/JPY as it currently sits above the levels that the Japanese central bank needs to boost exports. A higher depreciation could be harmful, but also a rapid appreciation like today’s would not be in the best interest of the BOJ if it wants to reach the 2 percent inflation goal.

Thursday, December 17
Tentative JPY Monetary Policy Statement
Friday, December 18
Tentative JPY BOJ Press Conference
Monday, December 14
7:30 pm AUD Monetary Policy Meeting Minutes
Tuesday, December 15
4:30 am GBP CPI y/y
5:00 am EUR German ZEW Economic Sentiment
8:30 am CAD Manufacturing Sales m/m
8:30 am USD CPI m/m
8:30 am USD Core CPI m/m
11:45 am CAD BOC Gov Poloz Speaks
Wednesday, December 16
3:00 am EUR French Flash Manufacturing PMI
3:30 am EUR German Flash Manufacturing PMI
4:30 am GBP Average Earnings Index 3m/y
4:30 am GBP Claimant Count Change
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
4:45 pm NZD GDP q/q
Thursday, December 17
4:00 am EUR German Ifo Business Climate
4:30 am GBP Retail Sales m/m
8:30 am USD Philly Fed Manufacturing Index
8:30 am USD Unemployment Claims
7:00 pm NZD ANZ Business Confidence
Tentative JPY Monetary Policy Statement
Friday, December 18
Tentative JPY BOJ Press Conference
8:30 am CAD Core CPI m/m

*All times EST