Today at 1900GMT the Federal Reserve will release its latest statement on monetary policy. In the past few weeks global central banks have been on a dovish tack. Last week, we had the Bank of Canada cutting interest rates, the European Central Bank’s €60bn per month asset purchase programme and now overnight, the central bank in Singapore has also eased its currency policy. The Federal Reserve is increasingly out on its own in terms of a central bank that is seemingly preparing for the beginning of its tightening cycle. So with the sharp correction in the US dollar yesterday, is the market beginning to think that the Fed might waver too?
There are two factors at work today. Firstly the wording of the statement. Generally the focus has been on the state of the economic recovery and the use of the term “moderate” and the piece on “considerable time“. This was extended by the Fed adding in a sentence including the word “patient” too. The three key sentences are below:
- “the Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace…”
- “the Committee judges that it can be patient in beginning to normalize the stance of monetary policy”
- “the Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program in October…”
It is likely that the Fed will maintain these three phrases as is. It may come to acknowledge the impact of disinflationary forces and if this is changed (currently “longer term inflation expectations remain stable”) then the market could take this as a dovish hint that the committee could be wavering on its path towards tightening.
We must also consider the composition of the FOMC in 2015. The new voting members have taken to the table. In the last meeting of 2014, in December, there were three dissenting voices to the statement. Richard Fisher and Charles Plosser (both significant hawks) thought the the Fed was being too cautious, whilst Narayana Kocherlakota (a significant dove) was concerned that the Fed was not paying enough attention to the decline in inflation below the 2% target.
However, these three dissenting voices (along with Loretta Mester who is also a hawk) are no longer voting members in 2015. They have been replaced with three doves (Charles Evans, Dennis Lockhart, John Williams) and a centrist (Jeffrey Lacker). This removal of reputedly the three most hawkish members of the committee the has skewed the FOMC significantly back towards the side of the doves once again. This could have a significant role in today’s meeting.
In the last three days, Sterling/Dollar has rallied around 350 pips, whilst in the last two days Euro/Dollar has bounced 250 pips. It looks as though there is a fear of a short squeeze coming through if the FOMC tilts slightly back towards the doves again. There has been a significant short Euro trade that has built up in the market in recent weeks. There could be a significant unwinding of these positions if the Fed shifts slightly. We have the euro currently trading around 750 pips lower in January there could be significant volatility tonight.