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Hawkish Fed sets date for start of QE roll-off

As expected the US Federal Reserve fired the starting gun on its plans to reduce the size of its balance sheet, with plans to begin the process next month, though with an initial $10bn roll off, it is likely to take a very long time, so much so you could argue that glaciers move faster.

The central bank also left interest rates unchanged, while at the same time signalling that they retained the option of raising rates one more time this year.

None of this should have been in doubt, particularly keeping the option of another rate rise on the table, given that any December decision still remains some distance away. The first rule of central banking is always making sure that all the various options are kept open, despite concerns about the economic damage caused by hurricanes Harvey and Irma, might do to their projections.

Policymakers also projected another potential three rate rises next year, the same as June, despite having to downgrade their inflation forecasts down from 1.7% to 1.5% for this year, and for 2018, from 2% to 1.9%.

What was surprising was that the FOMC revised up their growth forecasts from the June meeting for 2017 from 2.1% to 2.2%, a rather strange decision given recent weakness in the latest retail sales data, as well as the potential for further setbacks due to the damage caused by the recent transatlantic hurricanes.

It is true that the US labour market remains in good shape, but there still remains very little evidence of significant inflation of any kind. Nonetheless the Fed’s optimism did translate into a rebound in the US dollar index as it hit its highest level since the beginning of the month when the payrolls data was released, while US 10 year yields hit their highest levels since mid-August.

This rise in yields helped US bank shares rebound and push the Dow and S&P500 to yet another record close, however there still remains a significant number of data points between now and December, as well as the outstanding issue of the debt ceiling, which could derail the Fed’s intentions.

It also remains to be seen whether the Fed’s optimism about the prospects of a December rate rise survive first contact with the economic data between now and then, as it becomes clear the extent of the damage caused to the US economy in the third quarter.

In a busy 12 hours for central banks the Bank of Japan also sat down for its latest interest rate decision early this morning, and they will be pleased that the Japanese yen has slipped back in the last few days as the US dollar has rebounded. They also left monetary policy unchanged, though one board member dissented on the grounds that current policy should be eased further.

The pound had a rather mixed day yesterday, however it did get a boost after August retail sales beat expectations with a rise of 1% with equal rises in both volumes and value of sales. This suggests that even with prices rising consumers haven’t been deterred from spending money.

It also does nothing to undermine the prospect that the Bank of England will reverse last year’s questionable 25 basis point rate cut and put rates back to where they were in July last year at 0.5%. Some doubts are already being expressed about the wisdom of such a move, however with rates already at record lows, these concerns seem overblown. Today’s latest public sector borrowing numbers for August are expected to show a return to deficit of £6.5bn after July’s surprise £800m surplus.

ECB President Mario Draghi will also be speaking later today, no doubt pleased at the hawkish stance adopted by his US counterpart as the euro falls away from the 1.2000 level.

EURUSD – was unable to consolidate a move above the 1.2000 level falling well short of the 1.2090 level, and as such we could well retest the 1.1820 level. A break below the 1.1800 area is likely to prompt further weakness towards the 1.1600 area.

GBPUSD – made a marginal new high at 1.3660 before slipping back below the 1.3500 level. We have found some support at the 1.3450 area, but while above the 100 week MA at 1.3400 the bias still remains towards the upside. This weekly close shifts the bias for a potential move to the 1.4000 area. A move below the 1.3400 area retargets the 1.3320 area.

EURGBP – the failure to push beyond the 0.8900 area has seen the euro slip back. We do have support at the 0.8770/80 area, and a move below here has the potential to retarget the 200 day MA at around the 0.8700 area.  

USDJPY – has continued to move back towards the top of its recent range moving up to the 112.40 area and towards 112.70 which is trend line resistance from the highs this year. We now have support back at the 111.70/80 area.

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