It’s an action-packed week for global markets with a deluge of G20 central bank meetings and key economic data releases to contemplate ahead of the festive holidays, but none more bigger than the Dec FOMC meeting (Wed) – where officials are set to increase rates by 25bp, suggests Viraj Patel, Foreign Exchange Strategist at ING.
“With this fully priced in, markets will be more fixated on gauging the Fed’s future policy path. There are 2 factors to consider:
Persistently low US inflation dynamics. The Nov FOMC minutes highlighted the fact that Fed officials are currently scratching their heads when it comes to explaining the lack of inflation in the US economy. A flattened or dormant Phillips Curves was one of several reasons listed and the disappointing wage growth readings in the latest jobs report will have only compounded such concerns. We do not think markets are mispricing US inflation risks per se; banking on a dormant Phillips Curve relationship to suddenly ‘wake up’ has proven to be an unprofitable strategy for investors of late. Moreover, any US inflation ‘shock’ is unlikely to transpire overnight – there will be plenty of time for markets to adjust to any signs of brewing underlying inflationary pressures. For now, such signs remain few and far between – and trackers of long-run US inflation expectations (like the 5Y5Y breakevens) are right to be pricing in structurally lower price dynamics. It’s a tall order for the median Fed dots to shift lower, but we may see a slight downshift in the distribution.
The impact of fiscal stimulus on the Fed’s economic outlook. Odds of the Trump Tax Bill being passed have increased since the Sep FOMC projections and it will be interesting to see whether officials will incorporate any fiscal stimulus into their forecasts. We think it is too early for this, while some Fed officials have also downplayed the reflationary effects of proposed policies.”
“We expect to see the classic ‘buy the rumour, sell the fact’ type of USD reaction around the FOMC meeting this week – and see greater downside risks given the prospects of greater dovish tones emerging. DXY to fall back below the 93 level.”