The Fed’s language will be key for forex markets on Wednesday
This Wednesday, the US Federal Reserve is set to raise its key benchmark rate by 0.25%, its first upward move in nine years, signalling a return to a more normal monetary policy and a stronger USD.
However, with a market participants reckoning there’s a near 80% chance of this move happening it will in itself do little to move forex markets. The big mover will be the language of the statement that accompanies the move.
Current expectations are for a series of 0.25% rate hikes next year in June, though some expect as early as March, and September and December. Merely confirming that trajectory may lift USD, but probably not that dramatically.
To get some indication of the Fed’s road map, the statement will be scrutinised for comments about employment, inflation and forward looking monetary policy.
If the Fed talks about the pace of jobs gains accelerating, this is likely to be interpreted as hawkish – ditto for wage rises as this has implications for inflation.
Only two weeks ago, Fed Chairwoman, Janet Yellen said that a 100,000 new jobs a month is enough to absorb new entrants, at 200,000 a month it could draw ex-workers who had given up thereby increasing the low labour participation rate (no doubt dampening wage inflation). In effect, the pace of new jobs doesn’t have to be that dramatic for the Fed to keep raising rates, especially when the unemployment rate is only 5%. If it falls much below that level Yellen is clearly worried about the inflationary implications via wage rises.
Also, the Fed may leave out any reference to the pace of rate rises, words such as ‘gradual’ may not be included, which could be viewed as hawkish particularly if there are bullish references over the jobs market.
The is also likely to be some comments made about the outlook for inflation. It has picked up recently in the US, but remains comfortably out of the danger zone. Nonetheless, the Fed wants to nip any potential inflation burst in the bud. Given the turmoil in commodity markets and growth fears besetting the global economy, that shouldn’t be too difficult.
However, this rate rise comes against a very uncertain environment. Equity markets, which the Fed takes notice of, are jittery and corporate bond markets, especially at the lower end of the credit quality curve, are suffering problems, a strong USD is choking off US competitiveness and many emerging market economies are struggling.
Whatever the Fed says and does on Wednesday, it could turn out to be a relatively mild and short rate hiking cycle. Indeed, a number of other central banks have tried to tighten in recent years and soon reversed their stances – notably Sweden’s Riksbank and the European Central Bank.
The Fed could find itself in a similar position next year.
TECHNICAL ANALYSIS: EUR/USD – all pending Wednesday’s key announcement
Since the big shake-out of EUR/USD short sellers, the pair has moved steadily upwards as the ECB has so far failed to increase its monetary easing and the US Fed remains on course for the first rate hike in nine years.
Going into the crucial Fed announcement on Wednesday, the markets are likely to be steady followed by a big burst of activity once the news is out. With the markets taking a US rate hike as a given, the catalyst for movement will be in the language of the statement with a number of participants expecting it to be more hawkish in tone given recent strength in the US jobs market.
A particularly hawkish statement, could see EUR/USD challenge support at 1.0950, 1.0941, 1.0835 and even down to 1.0564 if the Fed suggests the next round of rate rises will come thick and fast. Indeed, the slow stochastics on the daily chart look close to issuing a strong sell signal, which has been relatively reliable in the past. However, news tends to supersede technicals.
However, EUR/USD has managed to continue rising recently despite the clear divergence in monetary policy between the Eurozone and the US. Therefore, a dovish statement – entirely possible given recent volatility in equity and credit markets could actually see the pair rise taking out resistance levels at 1.1043, 1.1059, 1.1108, 1.1124 and possibly even 1.1325 – if the Fed was to indicate that it’s a one-off rate rise (which is unlikely and not anticipated).
By Justin Pugsley, Markets Analyst, MahiFX