US Dollar, Yen May Rise on Hawkish Shift in FOMC Rhetoric

Talking Points:

Hawkish Shift in FOMC Rhetoric May Boost US Dollar, Sink Risk Appetite
Status-Quo BOE Meeting Minutes Unlikely to Spark British Pound Volatility
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All eyes are on the Federal Reserve monetary policy announcement in the hours ahead. This time around, the statement from the FOMC rate-setting committee will be accompanied by an updated set of policymakers’ forecasts for key economic indicators and the trajectory of interest rates. Fed Chair Janet Yellen will also hold a press conference.

The central issue at hand remains the likely timing of the first post-QE interest rate hike. Fed funds futures imply priced-in expectations for an increase sometime around November-December of next year. US economic performance appears to be accelerating anew however after a period of moderation from early September through late November. This may prompt the central bank to adopt a rosier tone, fueling bets on sooner tightening.

A key variable in the debate is the precipitous slide in oil prices. On one hand, the move has weighed on inflation expectations, which has been cited as an important reason for the Fed to maintain a relatively dovish posture. That seems unlikely however. For the consumption-driven US economy, the boost to incomes from lower energy costs supporting output growth and ultimately inflation may be seen as more significant than sub-target price pressure in the near term.

Relatively hawkish Fed rhetoric is likely to boost the US Dollar as traders adjust their timeline to reflect the onset of stimulus removal earlier next year. It may likewise amplify year-end liquidation flows, putting pressure on higher-yielding currencies like the Australian and New Zealand Dollars while boosting haven demand for the Japanese Yen.

Minutes from December’s Bank of England monetary policy meeting headline the calendar in European hours. Traders will be most interested in the voting pattern on the MPC committee. On one hand, a slight improvement in UK economic news-flow between the central bank’s November and December sit-downs suggests the doves probably did not expand their 7-2 majority. On the other, performance remained tepid and headwinds from the Eurozone continued to mount, meaning the hawks probably failed to make headway. On balance, this points toward a status-quo result, which seems unlikely to yield a strong response from the British Pound.

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