Morning Commentary: Is the Fed Approaching an End Game?

Foreign Exchange - Morning Commentary

Is the Fed Approaching an End Game?

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Alan Rose
Alan Rose
Foreign Exchange Head Trader
As we enter this holiday shortened week, markets are generally subdued and foreign exchange markets are mixed. There is a lack of prime first tier economic data this week and the markets will continue to react to last week's prime market moving news.  Here are some of the key stories and questions that the markets are following:
 
  • The market will continue to focus on the status of both the Brexit negotiations and the standing of PM Theresa May within her Tory party with the possibility of a vote of no confidence.
  • The collapse of the price of oil which saw 12 straight days of decline before finally stabilizing and the implications for energy and commodity linked currencies.
  • Is the Fed in the process of shifting gears and reevaluating its monetary policy forecast for continued interest rate hikes into 2019?
 
Late last week, Fed Vice Chairman Richard Clarida made comments that surprised the market by stating that “we are close to neutral” implying that the Fed was closer to the end game of this rising interest rate cycle going back to 2015. Less than a month ago, Fed Chairman Powell spoke and said that the Fed was “a long way from neutral” and the markets have interpreted the Vice Chairman’s recent comments as a correction of Chairman Powell’s apparent misstep.
 
Market are always looking forward and the Fed Funds future market has moved significantly. Clarida's comments combined with recent continued stock market volatility and turmoil are changing the expectations of future Fed rate increases. The December 2020 contract barely suggests 50 bp of tightening inclusive of a 25 bps hike in December.  This represents a significant downgrade from what was thought to be at least two to three more rate increases next year and is part of the explanation for why the U.S. dollar has fallen for five straight sessions.
 
Interest rate projections and interest rate differentials are critically important for almost all asset classes but in particular for the value of the U.S. dollar. How events unfold over the next weeks and months regarding Brexit, U.S. – China trade, and the future course of U.S. interest rate will play a key part in impacting how investors and traders will determine the value of equities, commodity prices, and the U.S. dollar.
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