Financial market research and analysis

At 7pm GMT the Federal Reserve will announce its monetary policy decision, marking the first-rate decision in 2018 and the last for current Chair Janet Yellen. The Fed hiked rates three times across 2017, however no change in policy is expected today.

There will be no press conference or forecast updates and this policy meeting is expected to serve as more of a farewell to Yellen, rather than the stage for policy change. That doesn’t mean that the meeting won’t be closely watched, and the accompanying statement scrutinised, with investors broadly expecting a slightly more hawkish Yellen in her final meeting.

What to expect:

March hike: In Yellen’s final meeting before handing the reins to Jerome Powell, the Federal Open Market Committee (FOMC) is widely expected to stick to the baseline case of three rate hikes in 2018. We expect an upbeat assessment of the economy and the language used in the statement is likely to continue to manage market expectations towards a March rate hike, for which the Fed fund futures are pricing in over a 90% probability of rates being raised.

Inflation outlook: The meeting is likely to be an upbeat event as lowflation concerns, which have been plaguing the Fed for most of the previous year, finally appear to be lifting. PCE, the Fed’s preferred measure of inflation, dropped from 1.9% last January to a low of 1.3% in August, before stabilising over recent months at 1.5%. Whilst this remains below the Fed’s target of 2%, it has at least started to move in the right direction. The weaker dollar and the recent uptick in inflation expectations could boost the Fed’s confidence in the inflation outlook, supporting 3, 25 basis point increases across the year. Meanwhile the US tax reform, uptick in business investment and strong US employment figures should also solidify the 3 times, base case scenario.

More hawkish panel, but this won’t show in inflation commentary: Whilst this is Yellen’s final meeting, it is also worth noting that new voters will rotate onto the committee. The changes will give the panel a more hawkish stance. We could at best expect more bullish commentary on the health of the US economy, but on inflation we expect Yellen & co. to stick to the repeated verse that inflation remains below target.

No changes to balance sheet reduction: We don’t expect any changes to the current balance sheet reduction plan. The previously announced timeline is not expected to be amended in any way or even highlighted in any significant way.

Potential market reaction:

The dollar has continued to move lower leading into the FOMC announcement, despite rising treasury yields, higher inflation expectations and the prospects of a more hawkish sounding Fed. The dollar was hovering close to three year lows sub 89.00 versus a basket of currencies ahead of the announcement, raising concerns that even a more aggressive Fed may not be able to stem the losses in the greenback. With the markets expecting a slightly more hawkish Fed, failure for Yellen & Co to live up to these expectations could see the dollar extend its losses closer to 88.44, last weeks three year low and on towards 88.00.

Historically USD/JPY sees the biggest impact from FOMC meetings. So far, the pair is holding steady at 108.7. Should the Fed present a more hawkish tone the USD/JPY could rise towards 110.00. However, such a move may prove to be challenging. The 5 day ma and 10 day ma have a bearish slant and with the 10 day ma at 109.44 any push above this level could be short lived.

On the other hand, no adjustments from the Fed could disappoint and weigh on the pair. Support can be seen at 108.28 (low 26^th Jan) before the doors open to 108.00


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