The US Federal Reserve meets for the last time in 2018. This could be the last event of such high importance in December. Another interest rate hike is nearly certain, but this time investors want to see not “what” the Fed does but “how” will it do it. In this analysis we present our point of view on the meeting and 3 markets that might be affected: USDJPY, Gold and US500.
Summary:
- Fed to hike rates, but 2019 communication crucial
- Markets see one hike next year at most
- Can the Fed be dovish enough to reverse the strong dollar?
The FOMC decision – it’s all about expectations
The Fed has increased interest rates 3 time this year already and the fourth hike has been very well communicated. Because the latest data from the US economy has been decent, there’s no reason for the Fed to panic and skip the final hike this year. Higher interest rates are normally positive for the domestic currency but since this hike is fully expected it will have little impact on the US dollar. The reactions will depend on expectations for 2019.
The Fed will communicate fewer rate hikes for 2019. But will this be enough to lead to a weaker dollar? Source: Bloomberg
In the last dot-plot presented at the September meeting the median “forecasts” was three hikes in 2019 on top of 4 moves this year. However, since the board members have more say than district presidents and they are more dovish, the understanding of the market was that the Fed communicated 2 hikes for 2019 and Fed futures nearly discounted this scenario. Because the global economy is already slowing down, the US will receive smaller fiscal boost next year and trade tensions may have a bigger impact there are expectations that Fed will communicate fewer hikes. But how many exactly? On the chart we can see the Fed futures (white line) are currently discounting less than 1 hike in 2019! Therefore, the Fed would need to actually be very dovish and suggest that they are making a longer pause after December to deliver (or exceed) these expectations.
3 markets to watch:
USDJPY
The Japanese yen usually gains in the times of uncertainty but it has seen only weak correlation with bonds and stocks lately and elevated US dollar has been a prime reason for this. Can this change this Wednesday? The pair has been in an upwards trend but now it remains locked in a triangle that could potentially spark a reversal if a support zone just above 112 is broken.
Gold
Strong dollar was a prime reason behind low gold prices over the past few years so the Fed policy is very important for the metal. Gold prices have been recovering recently and managed to break the $1235 barrier that now serves as a support. The mid-term resistance is at $1296.
US500
The US equity market is really looking for a lifeline from the Fed. The latest brutal sell-off has led the US500 to the lows from early 2018. Investors are concerned that the combination of strong dollar and high interest rates will cause a slowdown in the US economy in 2019 just when the impact of tax cuts will fade. The broken 2600 level now serves as a resistance with the 2530 low still acting as the “last chance” support.
