Markets
are almost certain that the Fed will be raising interest rates by 25 basis
points later today, suggesting that a rate hike has been already priced in.
Instead, the focus will be on the accompanying statement, economic forecast,
the dot plot and the Q&A session with Fed Chair, Jerome Powell.
Economic
forecasts are likely to be revised after President Trump signed the $1.5
trillion tax bill into law last December. This should be reflected in the GDP
growth forecasts for 2018 and 2019, but the magnitude of change is a hard
guess. Similarly, inflation and unemployment estimates are likely to see
upgrades from December’s projections. However, the key question remains - how
does such a change impact monetary policy tightening in the next two years?
The
answer to this question will be mirrored in the dot plot chart, and it is here
where most market participants are divided which makes trading the Fed a tricky
one. The latest dot plot, released in December’s meeting, shows three rate
rises in 2018, followed by another two in 2019, and reaching a range of 3-3.35%
by 2020. An upward shift in the dots, whether in the short or long term, will
have implications for the markets, and especially for the dollar, which has
been in a downtrend since late 2016.
If the
dot plot shows policymakers supporting four rate hikes in 2018 instead of
three, the dollar could surge by 1-2% against its counterparts. What could be
more supportive, is the lifting of long-term projections of interest rates
which currently stand at 2.8%. This will likely lead to a break of the 3%
benchmark on the 10-year bond yields. A steep move in bond yields should be
closely monitored given that a lot of investors point to 3% as the critical
level for equity markets. It is where corporate financing costs start looking
expensive and will attract stocks bears to come on board.
The
opposite case scenario is no change in interest rate projections and the Fed
sticking to the previous statement: "near-term risks to the economic
outlook appear roughly balanced, but the Committee is monitoring inflation
developments closely." Recent economic data supports such an assessment,
especially in view of the fact that home and retail sales disappointed
recently, and of course, the Fed will be taking the risk of trade war into
consideration. Under such scenarios, expect the dollar to continue falling in
the short run.
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