All eyes on the Fed and "patience"
Over the last nine months the US dollar index has risen nearly 25% from lows of 79.74 in anticipation that an improving US economy could well prompt the US Federal Reserve to change its stance on monetary policy, and start nudging interest rates higher over the course of the next few months.
Since 2012, the rise in the value of the US dollar against a basket of currencies has been even more marked, with the index up 40%, which in itself will have helped push down inflation in a country which has a substantial multi-billion dollar monthly trade deficit.
The evidence of the labour market would certainly appear to support the supposition of a possible rate increase, given the particularly strong increase in payrolls numbers in the past 12 months.
In the last six months alone we've seen 1.7m new jobs added, the best rate of jobs growth since 1999, while the unemployment rate has dropped to 5.5%, raising expectations that today's Federal Reserve rate meeting could well see a change in the forward guidance language in the Fed's statement, and the dropping of the word "patience", with respect to the timing of a potential rate rise.
When looking at the US economy through this prism it is easy to support a case for some form of tightening, but it completely overlooks a number of other key variables which markets appear to be completely ignoring.
Firstly wages growth continues to look weak, not altogether surprising given the record low participation rate, which would seem to suggest that there could be a lot more slack in the labour market than the Fed thinks.
Even if you put that to one side the Federal Reserve also has an inflation mandate, which it is currently missing by a mile. When one looks past the decline in the oil price over the last eight months core prices still look weak, and look to be tracking lower, while the so called consumer boost that this fall in oil prices was supposed to bring about hasn't materialised with retail sales and durable goods spending coming in at negative levels over the past 3-4 months.
Against this backdrop it is hard to imagine what would cause the Federal Reserve to adopt a more hawkish tone, despite expectations that it could well drop "patience" from the wording of its statement, with respect to the timing of a rate rise.
With inflation expectations already falling, and with oil prices at multi year lows it does appear fanciful to believe that somehow the Federal Reserve can fly against the breeze, with respect to its own monetary policy, when other central banks around the world, 20 odd at the last count, are guiding their expectations lower with respect to inflation.
Furthermore the recent Federal Reserve Beige Book also pointed to concern about the effects a stronger US dollar was having on manufacturers in Boston, Chicago, Cleveland, as well as the farm sector in Texas and California.
Given all of these facts the consensus view remains that we could well see "patience" removed from the statement. If it remains then an awful lot of people could well be caught the wrong side, causing a sharp selloff in the US dollar.
If it is removed then the US dollar could surge, but the Fed could offset that with a downgrade to the growth and inflation forecasts, which would certainly muddy the message. How would the market react then, because on the face of it surely that pushes back a rate hike.
This is where the following press conference by Janet Yellen could well pour oil on any troubled waters by stating that any move on rates remains data dependant, and the change of language in no way commits the Fed to an imminent move.
It will certainly require some nimble footwork on the part of the Fed to extricate itself from doing something that could well propel the US dollar even higher, which suggests that markets could well be overpricing expectations with respect to the outcome of today's meeting and subsequent press conference.
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