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Fed meeting in focus

By David Morrison  |  19/12/2018 15:05

There are so many moving parts and uncertainties as the Fed announces its last rate decision of 2018. This isn’t made easier by the simultaneous release of the FOMC’s quarterly Summary of Economic Projections

This is set to be the most important event of December as we march towards the holiday period. The US Federal Reserve concludes its two-day monetary policy meeting this evening and is expected to raise its headline Fed Funds rate by 25 basis points. According to the CME’s FedWatch tool the probability of a rise is around 70%. While this is high, it is some way below the 90%-plus probabilities seen ahead of recent quarterly Fed meetings. This suggests there are some doubts that the US central bank will go through with an increase. But the consensus is coalescing around the view that the Fed will announce a ‘dovish hike’. In other words, the Fed will temper the negative effect of a rate rise by signalling fewer hikes in 2019 when compared with its last forecast back in September.

The ‘dot plot’

Tonight’s rate announcement also sees the release of the FOMC’s quarterly Summary of Economic Projections (SEP). This is where the committee sets out its predictions for future GDP growth, unemployment, inflation and the fed funds rate. The latter is displayed in the ‘dot plot’ which shows all FOMC members’ (anonymous) forecasts for the US central bank’s key interest rate. Assuming the Fed does raise rates by 25 basis points, it could be that it expresses a ‘dovish pivot’ through the accompanying SEP. In September, the ‘dot plot’ strongly indicated a rate rise at this meeting with a further three in 2019. Since then, there’s been a pronounced deterioration in economic data globally. While US GDP growth has outstripped most other developed-world countries, it does appear to be rolling over. Earlier today, FedEx, which is viewed as one of the major bellwethers for the economy, slashed its 2019 forecasts and highlighted the “ongoing deceleration” in global growth. Meanwhile, there are also signs that US inflation may be peaking. Core PCE, the Fed’s preferred inflation measure, has fallen for the last two months, pulling back to 1.8% year-on-year to from 2.0% in September. We get the next update this Friday.  

The Trump dilemma

These would all be valid reasons for the Fed to tamper down the pace of monetary tightening, particularly as it continues to wind down its balance sheet. However, President Trump’s constant criticism of both the Fed and its Chairman Jerome Powell for raising rates has put the central bank in a difficult position. The US central bank is proud of its independence. Yet it runs the risk of being accused of pandering to Trump if it suddenly turns dovish now. After all, as some analysts have pointed out, at an annualised 3.5% for the third quarter, US GDP growth is still impressive. At the same time, inflation is only just below the Fed’s 2% target while at 3.7% the employment rate at its lowest since 1969 with wage growth picking up to its fastest rate in nearly 10 years. So, for the Fed to turn dovish now it will also have to express some concerns over the US and/or global economic outlook. This in turn could lead to a further sell-off in equities unless the Fed is extremely careful in how its expresses any concerns it may have. If the Fed holds back from hiking today, investors will start asking what exactly the US central bank is so worried about? Is it Trump, an imminent economic slowdown or have Fed members been rattled by the recent sell-off in US equites?

Dovish pivot?

There is a slew of important things to watch out for. To start with the Fed statement: will the Fed change the wording from “gradual increases” in the fed funds rate to being “data-dependent”? Also, will it shift from saying the risks to the economic outlook are “roughly balanced” to “roughly balanced but growing”? Either change would be dovish. Bad for the dollar but good for equities. But unfortunately, it won’t be that simple. There are so many moving parts to consider tonight even before we get to Chairman Powell’s press conference at 19:30 GMT. The algos will be instantly scanning the FOMC’s quarterly SEP for any downgraded forecasts for GDP growth, inflation, unemployment and the fed funds rate for 2019 and 2020. As far as the latter is concerned, all eyes will be on the ‘dot plot’ as mentioned above. If the FOMC continues to forecast three 25 basis point rate hikes for next year, then this would be very hawkish and market disruptive. Eurodollar futures are pricing in an increase of under 10 basis points in 2019. We should expect the dollar to rise and equities to fall on such news. If the FOMC prediction drops to two, or even one hike next year, then the dollar should fall, and equities could soar. But more than ever, we must be very careful about the initial market response. Since October sentiment has soured in a way we haven’t seen for many years. This makes tonight’s event difficult to read and sharp moves in either direction could unwind by the New Year, or even in a matter of hours.  
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