Wall Street indices gain and the dollar retreats ahead of the Fed decision at 7 p.m. BST 📣
- The market indicates a lack of an increase and the end of the rate hike cycle
- The Fed will publish macroeconomic projections along with a statement at 20:00.
- A press conference with Jerome Powell at the helm will take place at 20:30
The market expects the end of the rate hikes
The market doesn't give a big chance for hikes. Based on interest rate contracts, the market doesn't even give a 1% chance for a hike, while the consensus among analysts clearly points to a lack of increase. Is there then a chance for any surprise?
During the previous decisions, the Fed made it clear that it is constantly in the tightening phase of monetary policy, and hikes can be made every two or even three meetings. Theoretically, this would suggest a possible increase only in November, although it is worth remembering that we are after a fairly long holiday break. A surprise in the form of an increase cannot be ruled out, but the data does not provide a clear answer as to what to expect from the Fed.
The market doesn't give a chance for an increase. Source: Bloomberg Finance LP
Inflation fell, but oil is a big problem
The CPI inflation in the USA has been falling quite dynamically since June last year from a level above 9% to reach a local trough in June this year at 3%. The base effect obviously caused a rebound in inflation, but there is also potential for its further growth: a powerful rebound in oil prices, and thus fuel prices. Of course, the Fed has no influence on fuel prices, but they can cause a shift in inflation expectations and, as a result, among other things, a wage increase. Of course, the Fed doesn't want this. The second thing is the revival in the service sector prices. The service inflation excluding the real estate market has been a key indicator for American central bankers, and now a potential turning point can be seen. Although it is difficult to expect a further strong rebound in inflation from this level, the Fed may fear a return to the situation of the 70s when inflation rebounded quite quickly after initial declines.
Fuel prices rebound strongly, and prices in the service sector probably marked a turning point. Does this threaten a significant rebound in inflation? Source: Bloomberg Finance LP, XTB
The labor market finally shows signs of weakness
The labor market in the USA remains extremely strong, but we finally see any signals of cooling. The last NFP report came out below 200 thousand, but far more important were the revisions for the previous months. June was reduced to only 105 thousand, and July to 157 thousand. The market seems not to notice that employment growth over the last 3 months averaged below 150 thousand, and until May it was well above 200 thousand. Secondly, the unemployment rate rebounded to 3.8% from 3.5%, and the Fed in its recent forecasts still sees a level above 4% at the end of the year. This rebound is, however, related to the return of some people to the labor market. Wage dynamics slowed down to 4.3% YoY from 4.4%, which is the lowest level since 2021, but at the same time, it still remains too high to be consistent with the 2% inflation target. Unemployment benefit claims remain very low, just above 200 thousand, which is quite puzzling. However, at the same time, the number of open vacancies, or JOLTS – a very liked indicator by Fed chiefs has long shown a cooling of the labor market. On the other hand, the level of 8.8 million still remains very high compared to pre-pandemic levels when this indicator averaged just over 7 million. Nevertheless, the labor market certainly gives a chance for the Fed to decide not to increase and end the cycle of rate hikes.
The decline in new vacancies is quite dynamic and suggests that in the coming months employment may stop growing. Source: Macrobond, XTB
What to expect from the Fed's decision?
It is not an easy situation for the Federal Reserve and many scenarios could be considered. It is also worth remembering that besides the decision, the Fed will publish macroeconomic projections and expectations regarding rates. So what will be key for us in these projections?
- The last dot-chart indicated a median of rates at 5.6%. Since this is the middle of the rate range, it suggested an increase in rates to 5.75% at the end of the year, which theoretically gives a chance for one more move. Of course, the Fed doesn't have to raise it and may lower these forecasts.
- For next year, the Fed expects a rate of 4.6%. Maintaining this forecast without a hike could be considered hawkish. A reduction should, in turn, give a chance for a revival on Wall Street and a weakening of the dollar.
- Inflation forecasts will be important in conjunction with the unemployment rate forecast. Lowering or leaving the inflation projection and at the same time lowering expectations regarding the increase in the unemployment rate may mean a "soft" landing for the economy
As one can guess, for the market, the tone of the decision, projections, and conference will be more important than whether the rates will be higher or remain unchanged. The most likely scenario will be maintaining interest rates and a slightly less strong suggestion (than last time) that rates may still increase this year. Of course, the initial reaction may be negative for the market (declines on Wall Street and dollar strengthening), but in the coming weeks, the market should start enjoying the probable end of the rate hike cycle. A clear declaration of another hike ("we plan to raise at the next meeting or in December") will be considered strongly hawkish. Of course, there is also a chance for a scenario similar to what the ECB served – an increase and quite a clear declaration of the end of hikes. It would be a very dovish scenario, but it doesn't seem likely. Nevertheless, we have the smallest chances for an increase and a very hawkish tone of the whole meeting. Even the most hawkish members of the Fed did not suggest this.
How will the market react?
US100 closed the gap associated with rolling and finds the basis for rebound around 15350 points. The dovish tone of the decision may encourage the contract to test even 15500 points. On the other hand, a hawkish perception of the decision could give the ground again to test the 15200-15250 zone, although there it is most likely to rebound again.
EURUSD has been falling for 9 weeks in a row! Such a long streak has not been seen on the turnover for a long time. Nevertheless, the pair fell to an important support zone between 1.06 and 1.07. The decline was largely due to the weakness of the euro, but if the Fed's decision is perceived dovish, there will be a chance that this week there will be a weekly candlestick engulfing bull formation, which would require an increase to at least 1.0733. In the case of a hawkish perception of the decision or the first reaction, testing the 1.0610 level cannot be ruled out.