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FOMC on course for another 75 basis point interest rate hike

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21 September 2022

Written by
Matthew Ryan

Senior Market Analyst at Ebury, Chartered Financial Analyst. Providing expert currency analysis so small and mid-sized businesses can effectively navigate international markets.

This week in the foreign exchange market is all about central bank announcements, with this evening’s FOMC meeting the most important of the lot.

Summary:

  • FOMC expected to raise interest rates by 75 basis points this evening, with markets pricing in a non-negligible chance of a 100bp move.
  • We think that the market reaction will be highly dependent on the bank’s updated ‘dot plot’. A sharp upward revision to the terminal rate projection would be seen as bullish for USD, although expectations are sky-high.
  • Investors will have one eye on Thursday’s BoE meeting, which is a much tougher one to call.
  • We expect a 50bp rate increase from the MPC this week, although the vote among members may be a close one.

Leading up to today’s Fed decision, the US dollar has been on a bit of a role – something that investors have become all too familiar with in the past year or so. Last week’s blowout CPI inflation report, which delivered yet another upside surprise in the headline rate of US price growth, means that markets have high expectations in the run up to the meeting. Indeed, investors are now fully pricing in a 75 basis point rate increase at today’s meeting, while also seeing around a one–in–five chance of a 100 basis point move. This means that we could see some weakness in the US dollar in the event of a 75 basis point hike, although a lot will depend on the bank’s accompanying communications.

Recent US macroeconomic data has been mixed, although we do expect Powell to once again talk up the performance of the US labour market, which remains a bright spot and a reason for optimism among committee members. As always, the release of the Fed’s ‘dot plot’ will be key in determining the market reaction on Wednesday, with investors to pay close attention to the median dot for 2022, and the bank’s expectation for the terminal rate. We expect both to be shifted relatively markedly higher. At the June meeting, Fed members pencilled in rates of 3.4% by year-end, although we could see this raised to close to, or even above, 4%. An upward shift in the Fed’s terminal rate projection to between 4.25-4.5% or higher could, in our view, be bullish for the greenback.

Looking slightly further ahead, investors in the UK and overseas will have one eye firmly fixed on Thursday’s Bank of England meeting, which we think is a far more difficult one to predict than the FOMC. Since the bank’s last monetary policy meeting in August, a handful of developments have somewhat clouded the outlook on interest rates. Arguably the most significant development has, however, been the announcement from new Prime Minister Liz Truss that the UK government will be freezing energy bills at £2,500 for the average household from 1st October. We contest that the impact of the £100 billion fiscal package on interest rates is not necessarily as clear cut as one would expect. While near-term inflationary pressures are likely to be lower, medium-term inflation may end up being higher. This means that the decision between a 50 and 75bp hike is likely to be a close call this week.

On balance, we think that the Bank of England will raise interest rates by 50 basis points on Thursday, partly given both weaker near-term inflationary pressures and the MPC’s recent track record of surprising to the dovish side. At the time of writing, financial markets are pricing in around 68 basis points of hikes, so a 50bp move would be seen as dovish. In the event of such a move, we think that the reaction in the pound may, however, be guided by the voting pattern among MPC members. A close vote, with a handful of dissenters in favour of a 75bp hike, could be enough to support the pound towards the end of the week.

There is little macroeconomic news of note out in the next couple of days, so we expect attention to be firmly centred around the aforementioned central bank announcements.

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