USD/JPY: Will The Fed Deliver A Present Or A Lump Of Coal For Buck Bulls?

As he wants to do on many topics, President Trump has waded into monetary policy discussion ahead of tomorrow’s Fed meeting. Just yesterday, he tweeted, “I hope the people over at the Fed will read today’s Wall Street Journal Editorial before they make yet another mistake. Also, don’t let the market become any more illiquid than it already is. Stop with the 50 B’s. Feel the market, don’t just go by meaningless numbers. Good luck!”

While some analysts have correctly noted that Trump may have a point, the probability of a group of career economists making decisions based on their “feel” of the market rather than data is slim indeed. Moreover, the President’s public lobbying of an ostensibly apolitical organization is more likely to backfire than to succeed, as the central bank will be loath to be seen as bowing to political pressure. With traders still pricing in an above-70% chance of a move from the Fed tomorrow, the central bank should feel comfortable raising rates.

As my colleague Fawad Razaqzada noted in last week’s full Fed Preview report, the long-expected interest rate hike, assuming it arrives as expected, shouldn’t be a big market mover. Instead, the reaction in the US dollar “will now depend to a large degree on any potential changes in economic and interest rate projections the FOMC had made at its September meeting.”

After all, the central bank most recently expected three more interest rate increases in 2019, creating a sharp divergence with traders, who are only expecting a 50/50 chance of a single rate hike next year. With a dovish hike already well priced into the market, how far the Fed’s 2019 projections come back toward the market will determine whether the greenback will be able to extend its current rally.

A slight negative revision, with the median policymaker expecting two interest rate increases in 2019, appears to be the market’s base case at this point. Therefore, a sharp downward revision to just a single anticipated interest rate hike next year would likely lead to weakness in the US dollar and a recovery in beaten-down US stocks. On the other hand, a steady median forecast for three rate rises in 2019 could boost the buck and lead to selling in stocks as traders price in tighter financial conditions.

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