The Fed raised the Federal fund rate by 25 basis points and set the RRP rate at 0.25%. ‘This action marks the end of an extraordinary seven year period’ said FOMC Chair Yellen. The decision was unanimous. The dot plot projection was kept unchanged for the next year, while the rate target for 2017 and 2018 were revised lower by 25bp and 12.5bp to 2.375% and 3.25% respectively.
The US dollar rallied across the board, with the AUD, NZD and NOK taking the biggest hit, with JPY and GBP saw limited losses. The equity markets are painted in green.
The yield spread between the US and German 2-year bonds is widening with the anticipation of a follow-up in rate tightening, increasing the selling pressure in the euro versus the dollar.
The 10-year spread is less impacted, due to the dovish view on 2017/2018 as regards to Fed dot projections. The Fed could possibly proceed with additional four rate hikes through 2016, if the domestic and global macroeconomic conditions permit. In this context, the inflation will be a key indicator and downside risks prevail with lower energy and commodity prices and a stronger dollar.
The euro took a reasonable hit to 1.0832 against the US dollar as the Fed rate hike was mostly factored in. It is now time to rectify the post-ECB rally in the euro. Nevertheless, the market is still significantly short in the euro. Therefore the downside potential could well remain limited. Once the short book eases to reasonable levels, the fundamental shorts will creep in with a mid-term target unchanged at 1.05/1.0450.
Technically speaking, the slide below the Fibonacci support of 1.0855 (major 38.2% on post-Draghi rise) turned the short-term sentiment neutral from positive. There is still potential for a recovery back to 200/100-day moving average zone (1.1037/1.1058). A move above 1.1080/1.1120 (Fib 50% on Aug-Dec slide) could open the gate for an advance to the mid-term critical technical resistance of 1.1260 (major Fib 61.8%). Below this level, the divergence between the Fed and the ECB is still factored in.