Daily Commentary
 | 15/03/2017

FOMC decision: Signals on the rate path to drive the dollar

Today, the highlight for financial markets will be the FOMC rate decision. This will be one of the “bigger” meetings that also includes updated forecasts on the US economy, projections on the rate path, as well as a press conference by Chair Yellen. The Committee is widely expected to hike borrowing costs, with the probability for such action currently resting at 90% according to the Fed funds futures. This percentage skyrocketed from 26% in recent weeks, following an unexpected string of hawkish comments from several Committee members, who noted that the case for a near-term rate hike is very strong. This was surprising, at least for us, mainly because the underlying fundamentals of the US economy didn’t change following the February meeting, the minutes of which showed a cautious Committee. Economic data are short of spectacular, and uncertainty around the future of fiscal policy did not dissipate substantially following Trump’s speech to Congress. We considered these factors as providing ample reason for the Committee to remain patient for a while. Nevertheless, it seems that policymakers want to take action now and we think this may be related primarily to global, and not domestic factors, something suggested by Fed Board Governor Brainard.

Considering that a hike is almost fully priced in, we don’t expect a major market reaction in case the Fed simply acts as expected. Investors are likely to quickly turn their attention to the updated “dot plot”, for fresh signals on the rate path. We expect the “dot plot” to remain unchanged at this meeting, with risks skewed towards an upward revision. In her latest comments, Chair Yellen suggested that the process of scaling back accommodation in the future will probably not be as slow as it was in 2015 and 2016. We should also bear in mind that in December, only some FOMC members included expectations for greater fiscal policy in their forecasts. This suggests that as the outlook for fiscal policy becomes clearer, we could see the “dot plot” being revised higher, if not today, then perhaps in June or September. Even if the “dot plot” is left unchanged, we expect Chair Yellen to maintain the confident tone she adopted in her recent speeches. Such a stance by the Fed chief could amplify speculation for faster rate hikes in the future and thereby, bring the dollar under renewed buying interest.

USD/JPY traded somewhat lower yesterday after it hit resistance at 115.10 (R1), but the decline was halted by the 114.50 (S1) support. The pair has been trading in a sideways range between 111.60 and 115.50 (R2) since the 11th of January and thus, we believe that the short-term outlook remains flat. Nevertheless, an optimistic Fed Committee today could push the pair up for another test near the upper bound of the range, at 115.50 (R2). If the bulls prove strong enough to overcome that hurdle, then we may experience more upside extensions in the aftermath of the meeting, perhaps towards the 116.35 (R3) resistance level.

Dutch elections: Eurozone’s first political risk this year The other key event today will be the elections in the Netherlands. Dutch citizens will head to the ballots to elect a new lower house of parliament and consequently, their new Prime Minister. The results are likely to come in during the Asian morning Thursday. Investors are likely to keep an eye out for the outcome, mainly because one of the most popular candidates is Geert Wilders, the leader of the far-right Party for Freedom (PVV) and an outspoken Eurosceptic who wants to hold a “Brexit” style referendum. Thus, the prospect of his election poses a threat to continued European integration, something that could impact market sentiment overall. Wilders was leading the polling battle since November, with the center-right People’s Party for Freedom and Democracy (VVD), the party of the current PM Mark Rutte, holding the second place. However, recent polls suggest that VVD has now taken the lead. What’s more, according to recent polls, no single party is even close to reaching the 76 seats needed to form a government. This suggests that even in case PVV gets the first place in this election, Wilders would still need the support of several other parties to become the next PM, which is unlikely because most of them have pledged not to work with him. No other party supports his political vision for holding a referendum on leaving the EU. Even in the extreme scenario of achieving a coalition and getting the majority in the lower house, Wilders will still need a majority in the upper house before being able to even call for a referendum, but this is unlikely as well given that his party holds only 9 of the 75 upper house seats. These factors make the whole “Nexit” story seem almost impossible, in our view.

Now in terms of market reaction, in case PVV and Wilders do not manage to gain the first place in the election, the euro may turn up again, and EUR/USD could emerge back above the 1.0630 (R1) obstacle. Such a break could initially aim for the next resistance of 1.0675 (R2), and if buyers manage to overcome that zone as well, then it is possible that the pair will test once again the 1.0710 (R3) territory, marked by Monday’s peak. Nonetheless, we don’t expect such a rebound to evolve into a strong bullish run, as the next risk event for the EU, the French election, will be just around the corner. On the other hand, if Wilders is crowned as the winner, even if he does not manage to establish a government, his strong showing could add momentum to the campaign of the French far-right candidate, Marine Le Pen. Thus, a PVV victory may cause the euro to give back more of the gains it posted following the recent ECB meeting, and in combination with a rate hike by the Fed, it could push EUR/USD gradually lower for another test near the key 1.0500 territory.

As for today’s economic indicators: During the European day, we get the UK employment data for January. The forecast is for the unemployment rate to have remained unchanged, while average weekly earnings are expected to have slowed. A potential slowdown in earnings could bring GBP under renewed selling pressure.

As for the US indicators, we get CPI and retail sales figures, all for February. The headline CPI rate is expected to have risen, but the core rate to have declined. We think that investors may focus more on a potential slip in the core rate, as it strips out the effects of volatile items. As for retail sales, both the headline and the core figures are expected to have slowed. Although softness in both the CPIs and retail sales could hurt the dollar somewhat, we expect the currency’s forthcoming direction to be decided by the FOMC meeting later in the day.

USD/JPY

• Support: 114.50 (S1), 114.15 (S2), 113.55 (S3)

• Resistance: 115.10 (R1), 115.50 (R2), 116.35 (R3)

EUR/USD

• Support: 1.0600 (S1), 1.0570 (S2), 1.0525 (S3)

• Resistance: 1.0630 (R1), 1.0675 (R2), 1.0710 (R3)