Regardless of which way the Fed goes on Sept 17 markets are likely to be surprised
Global markets are waiting with bated breath to see whether the Federal Reserve will raise interest rates on Thursday – but whatever it does it will likely create surprise in some quarters leading to potentially explosive short-term volatility.
The situation is quite extraordinary. On the one hand many financial pundits are warning of dire consequences to markets and the global economy if the Fed pulls the trigger. On the other emerging market leaders are calling to get the rate hike over and done with to reduce uncertainty. They have a point, besides much of the hot money deflating their currencies may have already left in anticipation of tighter US monetary policy.
The Fed’s decision is clearly very finely balanced with contradictory comments coming out of various officials over the last month or so. Indeed, even the Fed is probably unsure at this stage in which direction it will go.
In the meantime, expectations for a September rate hike have fallen from 50% down to 25%. The likelihood is that it will be delayed with the outlook for the global economy becoming increasingly clouded with some analysts forecasting a more than 50% chance of recession within two years.
However, the US economy has been relatively robust, though inflationary pressures are still subdued. The US unemployment rate is now 5.1%, should it fall below 5% the Fed will worry about inflationary pressures building through wage rises.
Despite the low unemployment rate, the labour participation rate remains surprisingly low, suggesting that millions of Americans have given up on getting a job. If they have permanently left the workforce – then wage inflation may not be far off as the existing pool of workers will start to obtain higher salaries. Getting ahead of the curve in anticipation of such an event is probably the strongest reason for the Fed to act this week.
If the Fed does go ahead on Thursday, USD is likely to rally, possibly temporarily, though it would also depend on the language the Fed uses to justify its actions, which is likely to be dovish. Emerging market and risk currencies are likely to suffer the biggest set-backs at first.
A policy unchanged stance will likely see USD weaken as some traders positioned for a rate hike will liquidate their positions. Still there’s always the possibility of a muted response if the Fed does go ahead as it has been so well telegraphed to the markets. Going ahead would certainly remove one area of uncertainty and allow markets to properly reposition themselves towards a mildly tightening US monetary policy stance.
TECHNICAL ANALYSIS – EUR/USD volatility to dissipate ahead of announcement
On the technicals EUR/USD has pulled back a little from its recent recovery. In terms of positioning, the dailies remain in the middle of the Bollinger bands and the RSI has a very neutral reading of 57. As Thursday approaches, the pair are likely to see volatility further die down leading to more neutral readings from some indicators and mixed readings from more directional indicators such as MACD and the Stochastics.
Though it’s hard to tell how markets will react on Thursday, key support is placed at 1.1226 and 1.1022. Resistance can be seen at 1.1450 and 1.1621. Those levels should create a short-term area of containment for the pair.
By Justin Pugsley, Markets Analyst MahiFX