FOMC outcome: the market is right until it is wrong 20Sep16


FOMC outcome: the market is right until it is wrong

Michael O’NeillMichael O'Neill
FX Consultant / IFXA Ltd
Canada

  • Loonie sinking in ocean of crude
  • Bar is set low for a FOMC surprise
  • Oil bears should be cautious

doves

Fried dove on tomorrow’s menu? It’s happened before. Photo. iStock

By Michael O’Neill

FX trading volumes are lower than normal as traders sit on their keyboards patiently waiting guidance from the Bank of Japan and the Federal Reserve. Oil traders appear less concerned about central bank policies and are focused on Opec officials stating the obvious.

On Monday, Venezuela’s oil minister said that the world was producing about 10% more oil than demand required and oil prices dropped. That isn’t news. That’s why oil prices are where they are.

The Algiers meeting (Opec informal meeting) is only a week away. Oil bears should be leery of new price support comments ahead of the gathering otherwise they wouldn’t be having one.

Will the wait be worth it?
Olympic opening ceremonies are a big deal. At least for the host country that spends tens of millions of tax receipts to showcase their nation, their culture and their artistic talents.

In 1988, it was Seoul, South Korea’s turn to dazzle the world. They had big plans. The grand finale was the release of hundreds of doves to symbolise world peace and then the lighting of theOlympic Cauldron.

The big moment arrived. The doves were set free. The cauldron was lit. And then awe turned to “ick”. The doves flew into the flames.

And that brings us to Wednesday’s Federal Open Market Committee meeting. What will be the fate of those doves? Is Fed Governor Lael Brainard’s “new normal” the prevailing view at the FOMC?

On September 12, in Chicago, Brainard outlined five features of what she described as the “current economic landscape”. She concluded that “the costs to the economy of greater-than-expected strength in demand are likely to be lower than the costs of significant unexpected weakness.”

In her view, the Fed has all the tools it needs to respond to unexpected strength in the economy but if unexpected weakness arises, the tool kit is limited.

Financial markets agree with her assessment. There is only a 12% probability of a rate hike on Wednesday according to the CME FEDWatch tool.

Is the market view the right view?

The market is always right. Until its wrong. And when that happens the proverbial stinky stuff hits the whirling blades. Wednesday afternoon in New York, could be one of those days.

At least 88% of the market doesn’t believe that the Fed will raise the target range for Fed funds from a very low 0.25-0.50% to a very low 0.50-0.75%.

However, the FOMC may not be part of the 88%.

Last December they increased rates by 0.25% and suggested another 1% of rate increases in 2016. The Fed has repeatedly stated that the criteria for a rate increase includes a strong labour market and rising inflation.

The US labour market has been strong. Nonfarm payrolls have averaged 232,000 new jobs over the past 3 months and 168,000 new jobs since January. Not too shabby.

Chart: Change in NFP 2016
rates

Source IFXA/Bureau of Labor Statistics

The August inflation rise beat expectations, rising 0.2% vs a forecast for 0.1% gain, month over month. That is the other key indicator moving in the right direction to support a rate increase.

Janet Yellen seemed to be on board the rate hike express in August. In between fine dining and nature walks at the Jackson Hole Resort in Wyoming, the chair of the Federal Reserve said in a speech "I believe the case for an increase in the federal funds rate has strengthened in recent months." Afterwards, the vice chair, Stanley Fisher said that Yellen’s comments were a sign of how close the committee was to raising rates.

Strong employment, rising inflation and the top two Fed officials appear to support a change in the Fed funds range.

The market reaction to a rate hike would be nasty. The US dollar would soar, equities sink and doomsday prophets would dust off their “The World is Ending” signs.

The Fed would claim that they had set the stage for a rate increase for a very long time, a rate hike was justified and its not their fault that the market got it wrong.

The market would cry foul, volatility would rise and losses would be booked. And then it would be over.

A few days later a new debate would start as to whether or not raise would rise. Britain and the Eurozone didn’t implode when the Brexit vote was tallied and that result was a far bigger surprise to the world than a minuscule 0.25% US rate hike would be.

The answer to the "who is right or who is wrong" question will be revealed Wednesday afternoon.

— Edited by Clare MacCarthy

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Author: Loonieviews

In the past 30+ years, I have been an FX interbank market making trader, a high performing FX and Derivatives Sales person, creator of simple and complex risk mitigation strategies and a manager of high performance FX teams. The Trade of the Day is a culmination of that experience. Retail FX traders have access to a well-crafted and carefully researched FX trade strategy designed to generate FX profits while mitigating losses.

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