Capital Properties FX
Capital Properties FX

Conclusion After the Federal Funds Rate Decision

“In order to arrive at what you do not know
You must go by a way which is the way of ignorance.” – T.S. Eliot, Four Quartets, “East Coker”

The members of the Federal Open Market Committee gathered last Wednesday to issue another statement regarding the progress of the U.S. economy. As this meeting didn’t include a press conference, most of the market participants knew that the federal funds rate will remain unchanged. The FED didn’t surprise and the whole event was pretty much how majority expected it to be.

The U.S. dollar reaction to the statement was relatively mixed. Against the euro, the USD strengthened less than 50 pips which were re-traced fully the next morning. More or less the same applies to the British pound. However, commodity currencies didn’t do so well. Aussie took the strongest hit and closed more than 100pips lower compared to the daily opening price. Both NZD and CAD also suffered considerably more than the pound and euro.

In general, market’s reaction to the statement was dull. In itself, it’s not surprising as market participants depend on the dealings of the new U.S. administration, rather than the FED’s policies. Furthermore, the potential 0.25 percent increase in federal funds rate in June is almost 100 percent priced in. As a result, the market simply does not react much to FOMC meetings right now but most likely it will change.

Read Also: Advance GDP and Fed Interest Rates

Data Dependent Federal Reserve

The Federal Reserve wanted to hike the federal funds rate at least three times in 2017. However, since they claim to be data dependent, that forecast can change overnight. Being data dependant brings us to another point. In the recent statement, the members of the FOMC insisted that the weak Q1 GDP growth is most likely transitory. In other words, everything should be much better in Q2.

Unfortunately, there seems to be a problem with that assumption. In April we saw weaker than expected U.S. data. Hence, we are missing the signs of a magical recovery in the first month of Q2. Clearly, things can change in May and in June but for now, I wouldn’t hold my breath.

As the data so far is questionable, the FED can easily drop the June rate hike plan if the growth rate slows even more. 0.7 percent, in general, is already relatively low by the U.S. standards. Back in 2004 when the FED started to lift the federal funds rate from 1.0 percent, the quarterly growth pace in the States was firmly above 3 percent. Today, we are miles away from such figures.

Hence, the current slow growth rate may become a big problem for the Federal Reserve. If they indeed are data dependent, then the next rate hike is already hanging by the thread.

FOMC Statement Filled with Optimism

While the quarterly growth rate has dropped significantly, the FED considers it transitory and the overall language in the statement remained positive. The strength of the labor market and job gains are indications of a solid economy. Also, FED likes the current path of inflation as they saw it close to their longer-run objective which is of course 2 percent. In addition, the FED found that the near-term risks to the economic outlook were roughly balanced.

Generally speaking, the somewhat hawkish statement was enough for the market to conclude that the June rate hike is still on the table. After the statement, the rate hike odds for June surged from 70 percent to 94 percent. For now, it seems that we have all agreed that in less than two months, we’ll see the federal funds rate at higher levels.

Mixed USD Price Action After Federal Funds Rate Decision

U.S. dollar has been trading relatively unevenly lately. It has lost ground against the euro and pound while gaining ground against the commodity block and Japanese yen. Since the first round of French Presidential elections, EURUSD has moved more than 250 pips higher against the USD. In the same time, Aussie has moved more than 150 pips in the opposite direction compared to the dollar.

The mixed USD performance is a clear sign that the moves in major pairs are not USD related. The Canadian dollar is losing ground as the oil is once again making lower lows. Aussie and Kiwi, on the other hand, depend on China and the lowering demand for commodities there. Euro focuses on local issues and political risks.

The buying or selling the USD may come back as we get closer to June or when the U.S. data deteriorates further and the rate hike comes off the table. Also, it’s wise to keep in mind the old saying “Sell in May and go away”. The question is of course, what to sell – USD, EUR, AUD, NZD, CAD, JPY or GBP. The choice is yours!

Capital Properties FX
May 6, 2017

Read Also: Bank of Japan Policy Rate – April Meeting’s Outcome

Related Reading
US dollar money market funds and non-US banks.” Baba, Naohiko, Robert N. McCauley, and Srichander Ramaswamy. (2009).
Global current account imbalances and exchange rate adjustments“. Obstfeld, M. and Rogoff, K.S., 2005. Brookings papers on economic activity, 2005(1), pp.67-146.