Fed adopts a hawkish hike

CMC Markets

In a curious case of history repeating itself the US Federal Reserve raised interest rates by 25 basis points to 0.75%, a unanimous decision, while at the same time signalling a faster pace of increases in 2017.

At the September meeting Fed officials were projecting the potential for two rate rises over the next twelve months, however this has now been pushed up to three, if the dot plot chart changes are to be believed. 

This appears to be playing out in exactly the same way as it did a year ago when the dot plot charts also projected a faster rate path trajectory of at least four rate rises. That we are sitting here now having only seen one rate rise, you would have thought they would have been slightly more cautious in their outlook, and allowed themselves a little more wriggle room, even if the outlook economically is somewhat different.

While it is never wise to take the dot plot projections at face value, quite frankly they’ve been a lousy guide to what the Fed has actually done in the past few years, they do nonetheless paint a picture of how US policymakers see the US economy, though it is important to note they pay no regard to how external events can and do influence Fed policy.

In terms of that move in the dots, maybe Fed officials are more concerned about the prospects for a rise in inflation next year than they are letting on given the potential boost a fiscal stimulus could bring, which was something they didn’t have to consider last year.

As a result we saw the US dollar move sharply higher, as well as further losses for US treasuries. The stock market also didn’t like the sound of last night’s statement and press conference, with the Dow giving up its attempts to test the 20k level, sliding back sharply having fallen 30 points short.

The US 2 year yield also hit its highest level since 2009, above 1.26%, up 10 basis points, while the US dollar index hit its highest levels since January 2003.

What has become clearer is that the policy divergence that has been in place between the Fed and other central banks has just got bigger, and this is likely to put further upward pressure on the US dollar.

Yesterday’s UK economic data remained broadly encouraging with wages rising 2.5% in the three months to October, in the process just about maintaining a positive gap between wage growth and inflation, while unemployment came in unchanged at 4.8%.

Quite simply, while no one doubts that the UK economy has its problems, it remains in a much better place than a lot of people were predicting in July this year.

This is why today’s final Bank of England meeting of 2016 is likely to see interest rates remain on hold, with the prospect that further rate cuts are off the table for the foreseeable future.

If anything we might see the Monetary Policy Committee adopt a slightly less dovish tone, in an attempt to keep that floor under the pound that has been in place since the flash crash lows in October. The MPC will also have concerns over the prospect of higher inflation, given the moves higher in import prices that we’ve seen in the past few weeks, which has been reflected in sharply higher gilt yields.  

EURUSD – having failed to overcome the 1.0650 area we’ve drifted back lower and have moved below the 1.0520 area, with the 1.0460 area the next key support. We need to consolidate above 1.0650 to move towards the recent peaks at 1.0870. The prospect of further losses towards parity on a break below area the 1.0460 level, and 2015 lows remain a distinct possibility.

GBPUSD – the 100 day MA at 1.2760 continues to cap the upside, with the risk we could well head lower towards 1.2460 trend line support from the October lows. Only a move through 1.2300 opens up the potential to revisit the recent lows near the 1.2100 area.

EURGBP – the euro continues to try and push towards the 200 day MA at 0.8290, which remains a key support. We need to see a recovery back through 0.8480 to stabilise.

USDJPY – we’ve managed to push through the 115.60 level and closed above it which suggests the potential for further gains towards 120.00, while this level now holds. A move back below 115.60 would then suggest a move back towards 114.00.

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CMC Markets is an execution only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.