The Week Ahead – Mid-Year Budget and the Fed

Last full trading week of 2017 this week and only 8 trading days left for 2017, three main events this week – European CPI, RBA minutes and the final release of the US’ Q3 GDP.

The ‘battle’ across the Atlantic between the Eurozone and the US has been an interesting one as economic and monetary policy releases push EURUSD all over the place. It is actually trading in a sideways pattern however that range is over 4 cents. Definitely has the highest level of volume in it at the moment and is a pair to watch.

As the chart shows the initial spike up is the Fed releases the drop off is the ECB releases. One would have to expect similar movements this week around the data release just not on the same heights.

However, need to return to data from last as ‘Super Thursday’ was a huge mover of currencies and specifically the Fed.

Key points from the Fed release:

  • Raised rates by 25 basis points as expected – This means for the first time in 18 years the Australian cash rate and the Federal Funds rate are the same. Further to this the last time US Federal funds rate overtook Australian cash rate the AUD fell to 50c as the carry trade fled Australia – something to watch in 2018.
  • US GDP for 2018 was upgraded to 2.5% come June 2018 but back to 2.1% come December – the upgrade is being attributed to the Trump tax policy changes.
  • Inflation expectations were being pushed out to 2019 – targeted core inflation of 2% is not expected to reach this level on a consistent basis until 2019.

This brings us to the dot plots.

Board members retained the three rate rises in 2018 and two in 2019 – the long-term rate remains 2.75%. Interestingly in 2020 two members see the Fed funds rate at 4.25% – this hard to justify this.

However, from the trading perspective, it’s the market’s reaction to the new dot plots (illustrated by the purple line) that is the most interesting. It is flattening out even further – at time of writing the market is now pricing in one rate hike in 2018 with the possibility of a second sitting at just 60% that is a long way from the three the Fed is forecasting and is causing angst in the USD.

The flattening of the interbank market is most likely due to the inflation forecasting. The argument being the Fed’s (as it is for all central banks) main mandate is to maintain inflation at specifying levels normally around 2% – how can it be looking to increase rates when inflation just isn’t materializing in the US?

The AUD is one of the best examples of the market’s reaction to the Fed

(Source: IRESS)

The AUD added 1.2 cents in 24 hours this is despite the fact the RBA is unlikely to hike rates in the coming 12 months and Australian core data is soft. This shows how little the market believes the Fed can actually increase rates in 2018/19. It’s unfortunate, the AUD it needs to be lower however the USD just cannot hold a bid – it will be an interesting conundrum for 2018, and the structural decline in the AUD over the past 3 months appears over.

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