- With little expected from today's FOMC, the bar is low for a surpise either way
- Base case is a dovish hike, with minor adjustments to the statement
- Hawkish case; we rate the chance slightly higher than the market, but still low
- Dovish case; we see this as least likely, and no hike would be a massive shock
- EURUSD could test into 1.1400+ area on expected dovish downshift in guidance
Could the Fed be preparing a hawkish statement despite recent soft data? Photo: Shutterstock
By John J Hardy
There is little anticipation today that Fed chief Janet Yellen and Company will make waves at Wednesday's Federal Open Market Committee meeting, as the market has priced in a marginal dovish downshift, but with little expectation (judging from options volatility measures, at least) that there is much danger of a surprise. That means two things: fairly high odds that we see little to be surprised about, but also a low bar for a surprise either way.
Here are our scenarios:
Base case - dovish hike (strong market consensus): the rate hike is a given, some very minor changes to the statement that won’t amount to much, a lowering of the 2017 PCE inflation view, indifferent adjustments to the unemployment rate projections, and a weak press conference from Yellen that discusses the balance-sheet reduction without pinpointing timing and making everything conditional on economic performance. Generally USD-negative, but this is largely expected, so the immediate response is uncertain.
Hawkish case (we would weight the risk higher than the market, but still low-ish odds): in this scenario, the general tone is that the Fed is committed to excusing this latest soft patch in the economy, not seeing enough evidence in the recent data to shift the dot plot or its level of concern. The press conference would likely see Yellen offering fairly specific timing of balance-sheet adjustments, even if these are conditional on incoming data. One reason this risk is perhaps underestimated by markets is that Yellen may be hoping to polish her legacy as her term ends by February 1 of next year. Still, any USD bump, which could be sharp and sizable on such a development, might not have strong legs unless subsequent US data picks up notably.
Dovish case (least likely as the Fed likely hasn’t seen enough evidence to prompt a somewhat embarrassing change of direction in guidance, particularly given that Yellen may be in “legacy mode” as discussed above): Balance-sheet discussion takes place in principle only, and we see a notable downshift in the statement on the quality of recent data, a bigger adjustment in inflation and a sizable portion of the dot-plot forecasters shifting their near-term and medium-term forecasts lower. The massive shock scenario would be failure to hike, which is extremely unlikely.
A couple of first-tier data points — US May CPI and US May retail sales — are due ahead of the meeting itself. A massive surprise either way could easily colour the action into the FOMC meeting, particularly if the CPI is well above expectations.
EURUSD is perhaps one of the more sensitive USD pairs to USD weakness as the euro rally has had a bit of time to consolidate over the last couple of weeks and an as-expected dovish downshift in forward guidance could see EURUSD testing higher into the 1.1400+ area rather quickly. If the Fed surprises with a more hawkish stance than anticipated, the key zone of support shapes up between the recent 1.1110 area low/Fibo support and then what we view as the first major bull/bear line around 1.1000.
The G-10 rundown
USD - two-way risks over the FOMC are as outlined above, though market expectations are minimal and the USD-supportive scenarios may not provide durable support (which would demand that the long-gone "Trump trade" be reinvigorated).
EUR - the euro has been sidelined in an absurdly tight range. French president Emmanuel Macron's election victory brings enormous upside potenial for the French economy. Any euro weakness on the FOMC looks worth fading as long as we remain above 1.1000.
JPY - if US rates remain rangebound, the yen may be generally weak and possibly even weaker or unchanged versus a weak USD on a relatively dovish FOMC. If the FOMC is more hawkish, the JPY could weaken sharply.
GBP - surprised at the strength we've seen since yesterday - supposedly due to confirmation that Brexit talks are to get underway? Watching EURGBP and 0.8850 as the barometer for sterling.
CHF - The Swiss National Bank is up on Thursday - not expecting any waves, but if the FOMC comes with a hawkish surprise and bond yields pull back higher, it seems worth looking for places to get short of CHF.
AUD - AUDUSD is surging with no support from the commodities space, but plenty from risk appetite and rising Australian bank stocks. The employment report overnight will also weigh.
CAD – Bank of Canada's governor Poloz poured gasoline on the CAD rally with further comments supportive of the next move from the BoC being a hike, and Canadian two-year rates are at their highest for the cycle here. USDCAD is probably getting a bit overextended short term, but there's room to 1.3000 eventually if the FOMC doesn't support the greenback.
NZD - important GDP data tonight which will need to be supportive to justify this latest surge in the heavily bid-up kiwi. Last zone of resistance is into 0.7350-0.7450 in NZDUSD.
SEK - very supportive Swedish CPI yesterday puts 9.70 downside pivot in EURSEK back into focus.
NOK - Norges Bank's regions survey supportive for NOK. EURNOK may be capped for now and could push all the way back to 9.32 area if oil prices avoid new lows for the cycle.
Upcoming Economic Calendar Highlights (all times GMT)
- 1230 – US May CPI
- 1230 – US May retail sales
- 1800 – US FOMC rate decision/policy statement
- 1830 – US Fed's Yellen holds news conference
- 2245 – New Zealand Q1 GDP
- 0130 – Australia May unemployment rate/change
— Edited by John Acher