LCG Research Team: The US dollar is firmer walking into today’s Federal Reserve (Fed) verdict. Current activity in the US sovereign bond markets price in a meagre 22% chance for a rate hike to be announced today.
Therefore, the FOMC’s accompanying statement will certainly be the main talking point, as investors will be alert to any hint regarding the future of the Fed’s monetary policy. The main question is whether or not the Fed could hike interest rates at least once before the end of the year. The odds for a December Fed rate hike advanced to 58%.
We expect two-sided volatility in the US dollar crosses. Any dovishness from the Fed should signal a narrower divergence between the US’ monetary policy versus the rest of the world, and should allow the G10 majors to appreciate against the US dollar.
On the flip side, a less dovish than expected rhetoric could only widen the divergence between the Fed’s policy outlook versus the rest of the world.
The main risk to a hawkish Fed is the sensible dovish shift in the global monetary policies. As the Bank of Japan, the European Central Bank and the Bank of England display an ultra-expansive stance, the Reserve Bank of Australia and New Zealand leave the door open for more action if needed, it is difficult for the Fed to act alone.
The Fed should fine-tune its position to avoid a rush into the US dollar, which would potentially punch back via softer inflation and interfere with the long-term policy path. At the same time, the FOMC should keep the markets optimistic about the recovery in the US economy and build a case for a rate hike in the next six months to save its credibility.