Can the FOMC deliver USD-positive surprise?

24 November, 2016

With the EURUSD testing multi-year lows and USDJPY surging above 113 the US dollar index is at the level not seen since 2002. A pace of recent appreciation has been really strong so many investors wonder if the Fed - even if they increase rates which seems to be certain - can buoy the dollar further or perhaps it will be a profit-taking instead?

While there is still plenty of time left to the meeting, let us take a look at what has been already discounted by the market. First, we take a look at probabilities derived from market interest rates. 

Market is sure of the hike next month. Source: Bloomberg 

In this case we see that the hike probability seats at 100% which may look strange at first because there’s no "sure" thing on the market until it actually takes place. But this is simply a result of the way the probability is calculated - because the Fed maintains a range, not a specific target, actual short term market rate may move within the target and thus probabilities may not be precise. Nevertheless market is pretty sure the rate will take place and market reaction will depend on what’s beyond December.

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Expectations for future rates increased... Source: Bloomberg 

Market implied rates show us how much has been discounted going forward. Assuming a hike in December this is 1,5 moves next year and another 2 moves in 2018 - more or less. This is a significant change compared to August - in 3 months markets have discounted more than 3 extra hikes over a 3-year horizon. 

 ...but remain below the path indicated by the Fed. Source: Fed, XTB

However, when you look at the dot-chart from September (remember there was no chat over Trump’s inflationary policies and the US data looked softer) the market remains below the Fed consensus, especially over a long term. 

So may the Fed deliver a USD-positive surprise? Yes they can. What they need to do is to boost their dot-chart. By moving dots only marginally higher (especially for 2017 and for the long-term rate) they would pave the way for more market discounting and let this USD run continue. 

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