“The November 2nd FOMC meeting should be considered a placeholder meeting.
If the Fed is successful, the meeting will likely come and go without much action in the markets. We think the Fed’s objective is to signal that a hike is highly likely in December but that the path thereafter will be extraordinarily shallow. The market is pricing in a 72% chance of a December hike, which the Fed is likely to perceive as appropriate. Without a press conference or the release of the Summary of Economic Projections (SEP), the main form of communication is the statement.
There are two areas of focus: 1) statement of risks and 2) forward policy guidance.
We think the Fed will tweak both to show that Fed officials have become incrementally more comfortable with a nearterm hike than they were in the September meeting. One possibility is to change the risks statement to read “near-term risks to the outlook are roughly balanced”, which would be a change from “near-term risks to the outlook appear roughly balanced”. If the Fed wanted to go a step further, they could remove the word “roughly”, but we think they will wait to do so until they actually deliver the hike in December. There are a number of potential changes that the Fed can make to the forward policy guidance statement. One possibility is to add the word “further” in front of strengthened to read: “the case for an increase in the federal funds rate has further strengthened”. We also suspect that the Fed might want to remove the phrase “for the time being” since they are getting closer to delivering a hike. Importantly, we do not think they will turn to calendar guidance and explicitly mention that a hike is possible at the next meeting. The FOMC took this approach last October to signal a hike in December, but at the time the markets were only pricing in a 36% probability of a December hike. The Fed therefore likely felt it was prudent to take a more aggressive step toward calendar guidance in order to set market expectations. In our view, the Fed does not want to set a precedent of having to enact such strong signaling and will therefore avoid putting such language in the statement.
USD: a million risks but the Fed ain’t one…
A ‘placeholder’ status of the November meeting means it is unlikely to have a lasting impact on the dollar. A more explicit Fed signal of a December hike at the meeting would support but not accelerate the near 3% move in the DXY since the September meeting, in our view. With the market already pricing over a 70% chance of a December hike, we are cautious on chasing the USD move from here.
Additionally, a number of risks between now and the meeting, including the US election, Italian Referendum, and the European Central Bank’s December meeting area also a concern. If anything we see risks of some dollar consolidation near-term.
However, similar to the Fed’s December 2015, we see risks skewed towards further USD strength in the aftermath of a December hike with the market pricing less than one additional hike by end 2017, too low relative to our expectation for June and December hikes. Furthermore, if the new administration pursues a more aggressive fiscal expansion, this would certainly tilt the balance of risks to more hikes, supporting the USD”.
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