Talking Points:
- High yielding and emerging market currencies in focus today.
- Base case is for no rate hike, lower rate guidance.
- See the September forex seasonality report.
Market participants have more or less priced out the possibility of a September rate hike, with the Fed funds futures contract implied probability showing a 34% chance of a rate hike today.
The Fed (realistically) has one of two options today, and neither bode well for the US Dollar.
The first option would be for the Fed to raise rates, and announce that it would not do so again until its inflation half of the dual mandate is met. In this case, with a rate hike on the table, the USD could gain ground against the commodity currencies, but with equity market weakness also on the table, it could mean that the EUR and JPY are the big winners.
The other option would be for the Fed to not raise rates at this meeting, and at the moment, markets are pricing in December as the most likely period for the first rate rise (per the Fed funds futures contract). In this case, no rate hike could translate into renewed demand for riskier assets in the short-term, with equity markets rallying and AUD, CAD, and NZD picking up some more of their recently lost ground.
Seemingly no matter what the Fed does today, the real threat to the US Dollar comes from reduced expectations for future policy action. While the FOMC's projections will likely show improved forecasts for growth and the labor market and a weaker outlook for inflation, the Fed’s "dot plot," in which Fed members indicate where they believe the main rate will be at various points in time, will be front and center.
At the June meeting, the 2015 and 2016 rate forecasts were revised lower to 0.57% and 1.75% respectively, from 0.77% and 2.03%, respectively, in March. The June forecasts implied one or two rate hikes in 2015; the decision to do a “one and done” hike or delay it to the October or December meetings will further lower the projected rate path. As we saw after the last major policy meeting in June, reduced rate expectations (vis-a-vis the dot plot) have hurt the US Dollar.
Read more: One Last Data Hurdle to Clear for USD Pre-FOMC
--- Written by Christopher Vecchio, Currency Strategist
To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com
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