All Eyes on the Fed, Decision on Interest Rates Imminent

Approaching the long awaited meeting, it has to be a case of USD neutral until after the dust settles.

This article was written by David Dixon of Viper Wealth Creation. More about the authors at the end of the article.

All eyes 0f the market this week are on the two day Federal Open Market Committee (FOMC) meeting, which culminates on Wednesday, 7pm GMT, with their monetary policy statement and followed by Janet Yellen hosting a press conference 30 minutes later. The ‘will they, won’t they?’ regarding lift off for higher interest rates should be ended this week with an expected hike of the federal funds rate to between 25 and 50 bps, away from the longstanding zero to 25.

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In my opinion, it is this not knowing that has been the underlying cause of last week’s sell off in equities. Yes, there was a sharp fall in the price of oil and a ‘junk bond’ fund stopping withdrawals that led to some concerns around liquidity, but to me these were the catalysts and not the fundamental reasons. Why do I say this?

 

  • The effect of the lower oil price on investment and jobs is perhaps old news, and is not showing through in recent US job numbers. On the flip side, a lower energy price puts money in the consumer’s pocket to spend on services and goods that they otherwise would have had to spend on fuel. A good thing for stock markets.
  • The ‘junk bond’ market is a niche market with the clue in the name and unlikely to be a major disruption to system liquidity should some investors lose or have money tied up for an extended period. Not a Lehman event.

 

I mentioned last week that the EUR/USD was likely to follow the stock market’s lead and it duly obliged: on days when the equity markets sold off the euro rose while on

days of stability or slight pullback the euro came off the top. Last week the high was around 1.1040 with the pair ending at just under 1.1000 having bounced off 1.0940 which is a level that marks 61.8% of the move lower from 24th August to 3rd December. So it looks likely to follow this pattern with the next significant level at/or close to 1.1090 to the upside. If the market moves above this then we could quite easily see a move back to 1.1450/1.1500, the upper end of the prior range in play before the ECB ‘disappointment’ on the 3rd of this month.

 

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Looking ahead to the FOMC I see the EUR/USD impact based on the following possible outcomes:-

  • No change in rates – a BIG Greenback sell off to possibly 1.20 against EUR.
  • 25 basis points hike and a lessening in expectations of future rate increases on the fed ‘dot plot’ – 1.1450/1.1500 here we come.
  • 25 basis points hike and the ‘dot plot’ expectations stay the same as the previous statements then 1.1090 to hold and eventually the pair moves lower.
  • 25 basis points hike and the expectations are increased for faster rate hikes to a higher peak. Buy USD with previous low near 1.0450 breached and Parity this year.

In my opinion the first and last points are unlikely. Only the first outcome is going to mean an end to the trend lower on divergent interest rate policies. Should the Fed not hike after their recent rhetoric, they risk a serious credibility loss, while outcome four risks a Greenback run up that will hurt the chances of achieving the 2% inflation target.

It is a coin toss between outcomes two and three.

So approaching the long awaited meeting it has to be a case of USD neutral until after the dust settles.

I am encouraged by previously stated plays of long yen and short EUR and CHF on the cross which have weathered the ECB storm fairly well and maintained a lower bias. I see these as two main themes throughout 2016.

However before we kiss this year goodbye we should expect a lot of volatility as market liquidity dries up further.

Clive Arneil – Founder, Senior Dealer and Author

Clive ArneilClive’s experience spans some 20 years broking Forex and Derivatives markets mainly in the UK but also in Switzerland, Germany and the U.S.
Retiring from the money market at the age of 40 he went on to become a financial data feed specialist supplying market data to banks, brokers and spread-betting companies.
The next step was to go on to teaching people the skills required to master today’s volatile markets.
That knowledge has been passed on successfully not just in the U.K but also in Singapore, Dubai, South Africa, Germany and Italy.

David DixonDavid Dixon – Chief Dealer, Senior Analyst and Author

David’s trading journey started in 1980 working for Nat West for over 20 years. His focus was primarily in the spot, forward and derivatives markets.
Responsibilities included taking on proprietary positions on behalf of the bank in the ‘interbank market. In 2000 he moved on to become an advisor to
Corporate and private clients on various financial matters. In 2006 he joined Viper Wealth Creation.

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