Will the Fed deliver a long-awaited dovish pivot today?
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14 December 2022
Matthew Ryan is Ebury’s Global Head of Market Strategy, based in London, where he has been part of the strategy team since 2014. He provides fundamental FX analysis for a wide range of G10 and emerging market currencies.
Summary:
- Dollar drops by more than 1% as soft US inflation report increases possibility of dovish Fed pivot.
- FOMC set to raise rates by 50bps today, with ‘dot plot’ key to guiding market expectations for US rates in 2023. We think that two additional 25bp hikes are on the way in February and March.
- GBP and EUR both rally to June highs ahead of tomorrow’s Bank of England and European Central Bank meetings.
Currencies were thrust out of their recent slumber on Tuesday, as a softer-than-expected US inflation report sent the dollar sharply lower and raised the possibility of a long-awaited dovish pivot from the Federal Reserve at its meeting this evening.
Figure 1: US 3-month Annualised Core Inflation (2012 – 2022)
Source: Refinitiv Datastream Date: 13/12/2022
Yesterday’s CPI report has made investors more convinced than ever that the Fed will deliver a dovish pivot this evening. As we mentioned in our FOMC preview report, we think that a 50bp rate hike is a done deal. In the event that the Fed reverts back to a half a percentage point hike, which we think is all but certain, the key to the market reaction will be the Fed’s communications on the future path of policy in 2023 and beyond. We will be paying particularly close attention to any comments in the Fed’s communications that could answer the below questions:
Will the FOMC return to a ‘standard’ 25bp rate hike in February?
Where do members expect the terminal fed funds rate to land?
When can we expect US interest rate cuts?
Following Tuesday’s inflation miss, the answer to 1) appears increasingly likely to be yes, with the answer to 2) perhaps somewhat lower than believed 24 hours ago. The market will be guided chiefly by the Fed’s latest ‘dot plot’, which shows were each member expects rates to be at the end of each year. We suspect that most members see no more than 50bps of additional tightening in 2023, i.e two 25bp hikes in February and March, with rate cuts not on the horizon until late-2023 at the very earliest. Should Powell push back against the possibility of rate cuts in 2023, then we could see a modest correction in the dollar sell-off, though we suspect confirmation of a dovish pivot will be enough to satisfy the bears.
In the lead up to the meeting, the dollar shed over 1% of its value at one stage on Tuesday, with EUR/USD breaking above the 1.06 level and sterling rallying to its highest level since June. The next couple of days are very eventful ones for the ‘big three’ currencies, so expect volatility in these currency pairs, and indeed most currencies, to remain rather elevated between now and the end of the week. Thursday’s Bank of England and European Central Bank meetings will provide investors (and strategists for that matter!) with little chance to catch their breath. We will be covering out expectations for these central bank announcements in more detail during tomorrow’s update.
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