Hawkish Fed Statement To Unleash Dollar Bulls

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Includes: UDN, USDU, UUP
by: Tim Clayton
Summary

December’s Fed statement is likely to be more confident over higher inflation.

Easy financial conditions and the prospect of tax cuts also point to a more hawkish tone.

A more hawkish Fed statement is likely to push the dollar significantly higher.

The Federal Reserve is likely to issue a more hawkish statement at the December meeting with increased confidence that inflation will reach the target and more FOMC participants calling for a less accommodative policy. Overall, the statement is likely to be dollar bullish with the US currency also strengthening into the decision. The target for EUR/USD is 1.1550 with USD/JPY testing resistance above 114.20 and USD/CHF making a clear break above parity.

The final Federal Reserve policy statement will be released on Wednesday, December 13th. There is a very strong probability that the Federal Funds rate will be increased by a further 25 basis points to a 1.25-1.50% range, the third increase of the year.

The Federal Reserve Open Market Committee (FOMC) will release its updated economic projections, including the individual ‘dot plot’ projections of the Federal Funds rate for the next two years.

Fed Chair Yellen will also hold her final press conference before leaving the Federal Reserve at the end of January.

Assuming interest rates are increased, the main market focus will be on the Fed Funds projections, inflation rhetoric and commentary on fiscal policy.

The dollar came under pressure following release of minutes from the November 1st FOMC meeting due to doubts surrounding inflation trends.

Many participants observed that continued low readings on inflation which had occurred even as the labour market tightened, might reflect not only transitory factors, but also the possibility of developments could prove more persistent.

Given these concerns, these members suggested that the removal of policy accommodation should be quite gradual.

Some members, however, were concerned over upside risks to inflation given full employment and still very accommodative financial conditions.

At the December meeting, concerns surrounding persistently low inflation are likely to ease slightly. The global economy is on a stronger growth path, which will lessen the risk of global deflationary pressure and the dollar is still significantly weaker for 2017 as a whole.

Domestically, financial conditions have eased further and the New York Federal Reserve underlying inflation measure increased to an 11-year high just below 3.0%. The November Fed Beige Book also reported that price pressures had strengthened since the last report.

Overall, the FOMC members should be more confident that inflation will move higher during the year ahead.

The median economic projections in September, forecast that there would be a further 3 increases in the Federal Funds rate for 2018. The most likely outcome is that these forecasts will be maintained at the current meeting, although there is a chance that there will be a further small cut to the long-term forecast rate.

There is still an important element surrounding fiscal policy, but the likelihood of tax cuts has certainly increased with legislation approved by both the House of Representatives and Senate. The tax bills will now be taken to a reconciliation committee with Congress aiming to complete the process within 2 weeks.

Overall, there is a much greater chance that reforms will be passed into law this year with personal tax cuts taking effect in 2018. FOMC participants will continue to signal some caution, but there is likely to be some references to the risk that monetary policy will need to be tightened at a faster pace due to the impact of tax cuts.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.