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FOMC to hold rates, but how hawkish will it be?

Vantage Updated Updated Tue, 2023 December 12 11:27

Headlines

* US inflation cooled slightly as underlying price pressures stayed high

* Traders trim bets on 2024 Fed rate cuts after CPI report

* UK wage growth eases in sign of softening labour market

* Oil falls to five-month low as US, Russia bolster glut concerns

FX: USD eventually slid after a choppy reaction to the inflation data. A sharp drop to below the 200-day SMA at 103.55 was seen initially but prices reversed. The monthly headline CPI figure printed firmer than expected. Attention turns to today’s FOMC meeting.

EUR traded in the green as it touched its 200-day SMA at 1.0824 before retracing. There is a support zone around 1.0765. Germany’s ZEW survey showed some improvement in the expectations measure. The December print was the highest since March, possibly on hopes that policy easing is coming soon.

GBP printed a doji denoting indecision after making a high above 1.26. Wage growth slowed more than expected in the morning UK session. But US CPI hurt the dollar later on. The first rate cut is seen in June 2024. Cable needs to regain 1.26 to kick start some bullish momentum.

USD/JPY dropped as Treasury yields also edged lower. All eyes are on the Fed meeting today.

AUD printed above 0.66 before settling lower on the day below the 200-day SMA at 0.6574.

Stocks: US equities gained for a fourth straight day after initial selling from the CPI data was unwound. The S&P 500 added 0.46% to settle at 4643. The tech-laden Nasdaq 100 finished 0.82% higher to close at 16,354. The Dow moved 0.48% up at 36,577. Nasdaq led the gains while the Russell 2,000 small cap index underperformed. This index has been strong recently on the back of Fed easing bets.

Asian futures are mildly in the green. APAC stocks traded mostly positive on Wall Street’s advance. The Nikkei briefly reclaimed 33,000 on the open. The recent BoJ sources story which said the bank sees little need to end NIRP helped the risk mood.

Gold closed lower for a third day printing a narrow inside day. Focus is on the Fed and how much it pushes back on rate cuts. Oil prices tumbled to their lowest since June. WTI fell below $70 despite geopolitical tensions and the weaker USD. World oil demand growth forecasts were cut by the EIA.

Day Ahead – All about the Fed, Dots and SEP

An unchanged decision is nailed on so it’s all about the new dot plots and quarterly economic projections. The recent sharp fall in Treasury yields has caused an easing in financial conditions, which is undoing some of the Fed’s previous rate hikes. This seems too early for officials with inflation still sticky so a push back is widely predicted.

Policy rate projections, which currently have only 50bps of cuts for next year, will likely disappoint money markets. They see around 115bps of cuts next year. Will investors look through these dots given their poor track record? Or will they potentially instead react strongly, as was the case in September?

Expectations are for modest revisions lower in inflation and the unemployment rate, while growth should be lifted higher. Next year’s projections will be in focus as policymakers might forecast GDP higher in a hawkish signal, but then mark inflation down which would justify another rate cut for 2024.

Chair Powell could continue his style of downplaying the dots and projections in his press conference after the statement. But it is widely predicted the Fed will say it is still not talking about policy easing any time soon. This could dent the recent risk rally and hurt gold further.

Chart of the Day Dollar Index holding above support zone

How much will the Fed push back against the rate cut theme is the main question for markets. Talking up of an extended restrictive stance could help the dollar. It is then whether Powell offers anything to the softer inflation and growth outlook that is expected in the coming months. If he does not, then watch growth currencies like AUD and NZD, which have done well on the lower US rate environment, struggle.

The Dollar Index has traded sideways in recent days as markets await the big risk events this week. Note that the euro has by far the biggest weighting in the index. The 200-day SMA sits at 103.55 and the 50% point of the summer rally at 103.46. Major Fib levels either side are 102.56 and 104.38.