FOMC Preview: Cautious stance but risk tilted towards a more hawkish message – Danske Bank

Research Team at Danske Bank, suggests that the upcoming FOMC meeting is one of the small meetings without new ‘dots’ and a press conference.

Key Quotes

“As it is broadly expected that the FOMC will keep the federal funds target range unchanged at 0.25%-0.50%, focus is on the statement. Even though financial markets have taken Brexit very calmly and the US equity market is at an all-time high, we expect the FOMC to take a cautious stance due to possible negative spill-over effects from Brexit uncertainties. Still, risk is tilted towards a more hawkish Fed given the strong rebound in US data in Q2 (especially on the consumer side).

The reason why we expect the Fed to stay cautious is Brexit. Minutes from the last FOMC meeting stated that the Fed will have to ‘wait for additional […] information that would allow them to assess the consequences of the U.K. vote for global financial conditions and the U.S. economic outlook’. There have only been a few post-Brexit data releases, so it is still too early for the Fed to conclude anything and it would need more data to analyse the impact of Brexit on the US economy.

At the last FOMC meeting there was much discussion about the current situation in the labour market due to weak job reports in April and May, so the Fed will welcome the rebound in employment in June. The strong activity indicators in Q2 and the rebound in employment growth in June mean that risk is tilted towards a more hawkish Fed despite Brexit.

We think the Fed is on hold until next year but hiking theme could return if post-Brexit data stay solid

We still expect the Fed to be on hold until June 2017 and only hike twice next year (following hike in December 2017). Markets’ pricing is even softer as they have priced in just two-third of a hike this year and a total of 1.25 hikes by year-end next year (approximately). However, if it turns out that the US economy continues to grow steadily and the labour market continues to improve despite Brexit, the Fed hiking theme could return for real.

FX and rates

We expect the FOMC meeting to be neutral for the USD with risks skewed towards a slightly stronger dollar. The 2Y UST yield has room to rise further, which should support the USD. We expect EUR/USD to fall near term with our forecast pencilling in a fall to 1.07 in 3M driven by cyclical and monetary divergence.

US money market rates have moved higher after the recent strong numbers (non-farm payrolls and ISM) and as the US money market reform is moving closer. A FOMC acknowledging the better labour market numbers could reinforce the tendency for higher money-market rates as pricing of rate hikes is still very modest for 2016-18. The global hunt for yield is still keeping a solid lid on longer-dated treasury yields and a further flattening of the 2Y10Y is still in the cards for the next couple of months.”