It's very interesting to see markets rallying with only a few hours to an announcement that's supposed to be the riskiest event of the year. The Fed is about to pull the trigger on the first rate hike although being warned couple of times from IMF officials that raising rates could prompt a new credit crunch in emerging markets and risk derailing the global economy causing an equity market sell-offs. However, markets appear to have given fed the green light. Yesterday S&P 500 capped its first back-to-back gains since early November, Junk bonds rebounded after dropping to lowest levels since 2008, European stocks had their best day in 2.5 months, and oil prices stabilized after a steep fall.
The US Dollar rebounded yesterday after the DXY dropped to lowest level since Nov 24. Some U.S. data releases supported long positions as inflation pressures rose in November by 0.5% from a year earlier, beating 0.4% expectations, and the so called core CPI which excludes food and energy gained 2% to record the largest gain since May 2014 supported by rising rents, airline fares and healthcare cost. Although this piece of information would not change much in Fed’s decision today, it still provides more confidence.
The one million dollar question is how the US Dollar will react on the imminent rate decision. The USD long positions had been reduced considerably in the past couple of days and this is why the greenback dropped against it’s major peers. The European Central Bank taught traders an important lesson at the beginning of the month, it was to manage your expectations. For now, markets are looking for a 0.25% rate hike with dovish guidance reflected in the statement, projections, and Yellen’s speech. If FOMC succeeded in meeting expectations, markets most likely to move in tight ranges. However, traders should always be prepared for surprises.
Negative USD Scenarios:
- The most disrupting one is the Fed leaving interest rates unchanged. Although this option has a very low probability, we cannot rule it completely out, but the impact on the USD will be catastrophic, and the Fed will damage their credibility.
- Lowering the dots on the plot chart significantly were each dot represents where a FOMC member sees the federal fund rate at the end of each year.
- Raising interest rates by 10 -15 basis points rather than 25 basis points.
Positive USD Scenarios:
- Lifting rates and FOMC appears to be more confident in the future tightening path indicating another 3 – 4 rate hike to come in 2016.
Before today’s historic event some interesting data to watch from UK’s economy with the release of ILO unemployment. The unemployment rate anticipated to stay at 5.3% for October. However, focus should be on average earnings, which is likely to slip from 3.0% to 2.5% for the three-month period to October. On the Eurozone’s calendar, we are due to get preliminary manufacturing and service PMI data for December in France, Germany, and the Eurozone, along with Eurozone inflation figures.