The Federal Reserve gave clear indications on how and when they will unwind their balance sheet and three rate hikes still seen for this year, clearly dollar positive, at least short term. The Central Bank left rates unchanged, as largely expected, but indicated that it will start reducing its $4.5 trillion balance sheet by $10 billion per month, from next October. Also, the dot-plot showed that a third rake hike for this year is still on the table, as 11 of 16 Fed members consider it's appropriate, with the Fed funds futures now suggesting a 72% chance of at least one more rate increase before year-end, up from previous 51%.
FOMC Minutes release (October 11th - 18GMT)
FOMC members' speeches recap after September meeting
Speech total count
|Hawkish speeches: 10||Neutral speeches: 7||Dovish speeches: 6|
September Meeting Fed Dot Plots
If QE was crisis-era stimulus, the normalization announced yesterday means the end of stimulus. Nobody is getting this message just yet. The only concession to the new permanently lower natural rate is the ending point for Fed funds at 2.80% in the dot plot from 3% forecast in June. This is taken as a dovish signal for the longer-term, and while that's probably the correct idea, the immediate future has a hike in the cards. This is the classic short vs. long-term outlook.
The chart shows:
- Unprecedented balance sheet expansion in the post-GFC period was accompanied by a spike in gold prices to record highs above $1900 levels. Keynesians were running wild, calling hyperinflation, although nothing of that sorts happened.
- The bullish move ran out of steam in 2011/12 as Keynesians were proved wrong - massive balance sheet expansion did not lead to hyperinflation in the economy, but only ended up inflating the asset prices [asset price inflation/Dow rally]
- The Fed taper - realization that balance sheet expansion has ended - in 2013 also added to the bearish pressure around gold.
If balance sheet expansion led to asset price inflation[bearish for gold], balance sheet taper could lead to asset price deflation [positive for gold].
Fed is less data dependent, more focused on unwinding ultra-easy monetary policy - Yellen said yesterday that the Fed should be wary of moving too gradually. She felt that persistently easy policy can hurt financial stability and she sees risks of the economy overheating without modest hikes over time.
So far the gradual approach has been appropriate due to the subdued pace of inflation, but low prices likely reflect factors that should fade. Meanwhile, she added that it is “imprudent” to keep policy on hold until inflation hits the 2% target.
Yellen's comment on inflation indicates the Fed is less data dependent and more focused on unwinding the ultra-easy monetary policy. Back in June, the Bank for International Settlements [BIS] had asked central banks to press ahead with interest rate increases and to unwind the ultra-easy policy that has failed to boost inflation.
“If we leave it too late, it is going to be much more difficult to accomplish that unwinding. Even if there are some short-term bumps in the road it would be much more advisable to stay the course and begin that process of normalization”, the BIS said in June. Yellen & Co. seem to have taken the BIS' advice seriously.
During her press conference last week, Yellen also said that balance sheet unwinding will continue even if the economy faces short-term bumps and that the central bank will exhaust interest rate [cuts] first before moving onto QE/balance sheet expansion. So, the Fed would want to hike rates at a faster pace: the higher the rates are from zero levels, more will be the room to unwind the balance sheet.
Markets are yet to price-in the heightened odds of a faster-than-expected Fed tightening. Slowly but surely, investors are realizing that the Trump Bump, though desirable, is not necessary, i.e. the US economy is chugging along pretty well.
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Last release reactions
The Fed didn’t hike rates yesterday, saying that they will hike them one more time in 2017... They hiked rates into a weakening economy, and they did so hoping that inflation would rise… If you want your economy to grow you don’t hike rates! If you want inflation to rise, you don’t hike rates! And when you’ve dug yourself a hole, and realized you dug it in the wrong place, you don’t keep digging in the same hole!
If the Trump tax plan comes through and China PPI remains healthy, the Fed could indeed deliver 3 or even 4 rate hikes in 2018.
The Fed is committed to carry on the rate hike schedule (three increases for 2017) as indicated earlier this year. Barring a 'material' change in the economic outlook, the Fed should implement its rate hike and balance sheet normalization policies any planned.
We suspect George was the author of the highest dot (2 rate increases this year). Williams should have been in the majority camp (1 rate hike), while Kaplan might have been in the majority group (1) or one of the four governors who projected no rate hike anymore in 2017.
News & Analysis
FED latest analysis
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The FOMC Experience
Follow all the relevant information through our key points below:
1. Price Scenarios
- The pair is within a consolidative phase ever since late August, overall maintaining the bullish long-term stance, as in the daily chart, the price remains well above an ascendant trend line coming from early April, currently around 1.1820, whilst the price remains far above bullish 100 and 200 SMAs, and around the 20 SMA, which losses upward strength. Technical indicators in the same chart hold within positive territory but lack directional strength.
- The pair has an immediate resistance in the 1.2030/60 region, with gains beyond the level exposing firstly the 1.2101 level, January 2015 high. Beyond it, the rally can extend short-term towards 1.2140/60, while a daily close above 1.2100 will open doors for an extension towards 1.2300 in the following days.
top,and further slides ahead.
- 1.1910 is the immediate support, ahead of the critical 1.1820, where the pair has the mentioned trend line and a relevant weekly low from August. Further slides below this level will leave the pair poised for a deeper downward corrective movement, down to August 17th low at 1.1661.
- The spot currently trades above the 200-DMA of 111.47. The 14-day RSI is above 50.00 and yet to hit the overbought territory. However, the Stochstics [5,3,3] is overbought, thus a minor pullback could be seen..
- Bulls have nothing to worry about unless the spot closes below the 10-DMA, which currently stands at 110.11.
2. What to expect this time?
Context & info of the event - Balance sheet normalization expected, not a rate hike
Fed will begin the process of balance sheet normalization - This is going to take time... a long time, even if we assume there are no hiccups/economic shocks on the way.
The Fed has said that whenever it begins with the balance sheet normalization process, it's going to trim the balance sheet by $10 billion a month for the first three months, $20 billion per month for the next three, and on and on until it hits a pace of $50 billion per month.
Before it starts cutting, it would first stop reinvesting the maturity proceeds. Markets expect the Fed to start cutting the balance sheet from October/December, depending on how the markets and the economy react.
Fed Interest Rate Hike
Key things to watch on the statement
- No change in rates - No one expects the Federal Reserve to hike rates. If it does, it would be an absolute stunner, sending US yields and the USD higher across the board.
- Fed may drop hints about the Dec rate hike: The federal reserve funds futures market at Friday's close showed a slightly less than 50% chance of another rate hike this year. The hint may come through policy statements and/or the dot plot chart.
- Less Dots in favor of another rate hike in 2017. Markets believe the 'dot plot' chart would show less support for December rate hike. In June, twelve of the sixteen dots had shown at least one more rate hike by the end of 2017. The committee is expected to signal a modestly flatter interest rate path and increased concern.
US Inflation expectations vs China PPI
- The chart above clearly shows, it was the Chinese PPI that set the ball rolling mid-2016. Chinese PPI and the US 5y,5y forward inflation expectations topped out in the first quarter.
- Following the spike in the Chinese PPI in August, speculation is gathering pace that the world's second largest economy is reflating and shall end up pushing the US inflation expectations higher. The Fed's preferred gauge now stands at 1.4 percent and is likely to follow the rise in the Chinese PPI and US inflation expectations..
Forecasts - Can the greenback be saved?
What can then, the Fed do in this scenario to save the greenback? Well, almost nothing. Unless a surprise rate hike is announced, with doors opened for also a December hike, dollar possible gains won't be sustainable in time. The US administration has hinted that the tax reform will be discussed by the end of September, so a hawkish Fed, plus some positive news on the issue by the end of the month, could be the beginning of the end of dollar's decline, but that's the most it could be said at this point.
3. What to expect in the future?
Future events, future hike odds
The hawkish surprise may come through in the form of:
- Strong December rate hike hits
- Dot plot chart
- Talk of faster balance sheet normalization
- Fed chair Yellen may downplay weak inflation and express concerns regarding the easing of financial conditions this year despite rate hikes
Strong hints of the December rate hike would shift focus back to the 2-year treasury yield from the 10-year yield. Thus, a flatter yield curve would once again become USD bullish.
What's important about Federal Reserve’s monetary policy meeting?
With a pre-set regularity, a nation's Central Bank has an economic policy meeting, in which board members took different measures, the most relevant one, being the interest rate that it will charge on loans and advances to commercial banks.
In the US, the Board of Governors of the Federal Reserve meets at intervals of five to eight weeks, in which they announce their latest decisions.
A rate hike tends to boost the local currency, as it is understood as a sign of a healthy inflation. A rate cut, on the other hand, is seen as a sign of economic and inflationary woes and, therefore, tends to weaken the local currency.
If rates remain unchanged, attention and also main news and analysis turn to the tone of the FOMC (Federal Open Market Committee) statement, and whether the tone is hawkish, or dovish over future developments of inflation.
How to trade the event?
- Do not rely on the Fed to determine the direction of the dollar in the coming months.
- The dollar tends to follow its predominant trend when the Fed starts to hike rates.
- There is no direct link between the Fed hiking rates and the usd falling. When a weak usd has coincided with a Fed hiking cycle, it has been falling for some time.
- Due to this, we may see a muted reaction to a potential Fed rate hike.
FED educational resources
What is the Fed?
The Federal Reserve System (Fed) is the central banking system of the United States and it has two main targets or reasons to be: one is to keep unemployment rate to their lowest possible levels and the other one, to keep inflation around 2%.
The Federal Reserve System's structure is composed of the presidentially appointed Board of Governors, partially presidentially appointed Federal Open Market Committee (FOMC). The FOMC organizes 8 meetings in a year and reviews economic and financial conditions. Also determines the appropriate stance of monetary policy and assesses the risks to its long-run goals of price stability and sustainable economic growth. FOMC Minutes are released by the Board of Governors of the Federal Reserve and are a clear guide to the future US interest rate policy.
WHO IS FOMC'S CHAIRMAN?
Janet Louise Yellen (born August 13, 1946) took office as Chair of the Board of Governors of the Federal Reserve System (Fed) on February 3, 2014, for a four-year term ending February 3, 2018. She had already previously served as a Vice Chair from 2010 to 2014. This American economist also serves as Chairman of the Federal Open Market Committee (FOMC), the System's principal monetary policymaking body.
The World Interest Rates Table
The World Interest Rates Table reflects the current interest rates of the main countries around the world, set by their respective Central Banks. Rates typically reflect the health of individual economies, as in a perfect scenario, Central Banks tend to rise rates when the economy is growing and therefore instigate inflation.