Markets to be disappointed on dovish hike - BTMU

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Dec 16, 2015.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    FXStreet (Guatemala) - Derek Halpenny, analyst at Bank of Tokyo mitsubishi explained that is is a high barrier for Yellen to jump to meet dovish expectations.

    Key Quotes:

    "The FOMC will raise the range for the federal funds rate tonight by 25bps, the first increase since June 2006 and perhaps the most well anticipated central bank move in financial market history. In September when the FOMC balked at raising rates at the last minute, the statement made clear that the committee wanted to see “further improvement in the labour market” and to be “reasonably confident that inflation will move back to its 2% target”. Since then, employment has increased by 654k, the unemployment has dropped 0.1ppt to 5.0% and the 3mth annualised increase in wages picked up to 2.4%.

    On the inflation front, the CPI report yesterday was compelling in helping lift FOMC confidence on achieving the inflation goal. The core annual CPI rate hit 2% for the first time since May 2014 and ex-energy service CPI increased to 2.9%, the sixth consecutive increase and the highest level since November 2008. Medical care/insurance inflation is also surging (insurance was up 3.6% y/y) and the weighting for medical care is far higher in the PCE price index than in the CPI (7.8%) pointing to the strong likelihood that the annual PCE price index is about to accelerate from the current 1.3% level. While commodity prices and the dollar are keeping overall inflation in check, it is clear that domestically generated inflation pressures are building and the evidence at least gives the Fed the justification to begin lift-off today.

    So how can Chair Yellen impress the market and meet already very high expectations of a ‘dovish rate hike’. We suspect this is going to be very difficult and certainly view the risks as being skewed towards the market being disappointed with the level of dovishness.

    In May 2004, one meeting prior to the last FOMC lift-off, Chairman Greenspan used the word “measured” for the first time to describe the rate tightening path. “Measured” it certainly was with 17 consecutive 25bp hikes. That course of action is now widely criticised and we can forget the FOMC using a term like that this evening. The use of the word “gradual” in describing the pace of tightening is certainly possible but in reading Chair Yellen’s speech from 2nd December it was clear to us that the one common view within the FOMC is that the pace will be tied to incoming economic data. The FOMC wants to do away with pre-commitments and tie the path to “actual” inflation readings, jobs data and the outlook going forward. That may well be made clear in tonight’s statement, or certainly at the press conference.

    Of course, whatever is in the statement or mentioned by Yellen in the press conference, the DOTS path will still probably prove the key communication tool at the outset. Expectations are high of a shift down in the projected path. While we expect that for 2017 (maybe from 2.63% to 2.50% or even 2.38%), possibly justified on a lowering of the long-run federal funds rate from the current 3.5%, the lowering of the DOTS in 2016 is less clear. Don’t forget, by acting this evening, the FOMC is confirming the first DOT from the September projections and hence it will prove difficult to justify a lowering of the 2016 path, especially given if anything the data on inflation and jobs since September have strengthened the case for higher rates. So the risk is that the 2016 DOTS do not come down as expected.

    Finally, there may well be one or even two dissents this evening (Evans & Brainard?) but the composition of the FOMC will become more hawkish in January with Evans, Williams, Lockhart and Lacker being replaced by Bullard, George, Mester and Rosengren – one dove, two neutrals and a hawk being replaced by 3 hawks and a dove.

    As for the dollar, we feel the risks are skewed to the dollar performing better than expected given the high dovish expectations going into the announcement and press conference. Even if Yellen does manage to meet these expectations and weaken the dollar further, it ultimately is all about the incoming economic data and that is likely to limit the scope for dollar weakness. If risk appetite is restored and short-term yields move higher in the US, prospects for the dollar versus the major currencies look good while EM FX might undergo some recovery."
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