Markets are preparing for the Federal Reserve announcement tonight. The big question that has dominated market chatter over the past few days has centered around just one word, “patient”. This is the word that apparently prevents the Federal Reserve from hiking interest rates in the net two meetings. However, many in the market are convinced that this will be removed today, heralding the Fed rounding the final corner and entering the home straight on the course towards resuming monetary tightening. So what will the FOMC do?
The dollar has soared in the wake of another strong Non-farm Payrolls report. The Fed describes the labor market as “strong”. But for me, not a great deal has changed recently, except for the strong payrolls report this month, which showed the latest payrolls sharply higher to 295,000 from a revised 239,000 in January.
There is a series of economic factors that tell me that the US economic recovery has just begun to tail off in recent weeks:
All this said, I expect that the FOMC will disappoint the market today. Quite how this disappointment manifests itself is difficult to say. It could remove the word “patient” in order to give itself some flexibility, but also remaining cautious by adding a sentence about “data dependence”. If this is the case then the market could view this as a slight disappointment as the economic data (as shown above) has not been great recently. I think that this could drive a near term rally against the dollar as the market realizes that the dollar strength has gone too far too fast. However, the dollar strength is ultimately correct and the rally is not likely to be huge before the dollar bulls regain control. It is interesting to see that the yield on Treasuries has dropped in recent days as this dollar consolidation has set in. Could this be the bond markets telling us that the dollar has gone ahead of itself in the near term?
The big strong dollar trade this evening would be driven by removal of “patient” and alluding to an expectation of inflation picking up. This could result in an acceleration of the dollar, driving EUR/USD, GBP/USD and gold all lower.
The biggest surprise would be if “patient” were to be kept in the statement. This could cause a significant shock to the dollar bulls and there could be some considerable short covering on euro, sterling and gold trades. Quite how high this would drive EUR/USD, GBP/USD in the near term would be hard to judge but the move could be sizable in the near term considering the 5% dollar strength in the time since the Non-farm Payrolls data.
This certainly promises to be an extremely interesting announcement tonight, with a big range of expectations from analysts. For that reason alone, expect lots of volatility not only on the release of the statement, but also during the Yellen press conference.