3 Possible Scenarios for December’s FOMC meeting

3 Possible Scenarios for December’s FOMC meeting

Scenario #1 – Fed Hikes, Yellen Provides Zero Forward Guidance

If the Fed raises interest rates and Yellen provides zero insight into when rates will rise again, the U.S. dollar should fall. Given how quickly and aggressively the U.S. dollar has appreciated over the past month, profit taking is long overdue. While part of the move can be attributed to Donald Trump’s spending plans, the man isn’t even president yet the markets are moving like he’s already rolled out a major fiscal-spending program. Structuring the program and getting it past Congress could take much longer than the president-elect expects and the eventual package may be far less impressive as Senate members worry about financing costs. So if Janet Yellen fails to convince the market that rates will rise again in the first quarter, we foresee a 1-2 percent correction in the dollar in the days that follow.

 

Scenario #2 – Fed Hikes, Yellen Signals Long Pause

If the Fed raises interest rates and Yellen talks about the impact of rising yields and/or confirms that future rate hikes will be data dependent — which would mean she’s not committing to any future moves — the dollar will also fall, and more aggressively than in scenario 1. Profit taking into year-end is not unusual, especially after the big moves that we have seen over the past month, but in this scenario, there will be continuation and selling the dollar — even as it falls should be a fruitful trade. We expect the strongest moves from USD/JPY and EUR/USD — two of the currencies that have fluctuated the most on U.S. dollar strength. But with that in mind, all currencies will rise against the dollar in this scenario.

 

Scenario #3 – Fed Hikes, Yellen Emphasizes Need for More Tightening

If the Fed raises interest rates and Yellen expresses her optimism about the economy, raises concerns about rising inflation and emphasizes the need for more tightening, the U.S. dollar will soar. We will easily see 115 in USD/JPY, 1.05 in EUR/USD will break and AUD/USD will make a run for 73 cents. Fed fund futures tell us that unambiguous hawkishness and strong forward guidance is not expected, so we should see multi-day/week continuation.

 

But at the end of the day, the December FOMC meeting may prove to be a big disappointment in terms of market volatility. Everything has led up to this point and investors have had plenty of opportunity to prepare for the move. Scenario 1 is the likeliest because yields have increased and the Fed needs time to see exactly how much fiscal stimulus the Trump administration can or will provide. Yellen won’t commit to anything, dollar bulls will be disappointed, giving investors a good reason to take profits on long-dollar positions into year end. Which does not mean that the dollar rally is over, instead we should see more two-way demand.

 

by Kathy Lien, Managing Director of FX Strategy for BK Asset Management

 

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