Financial market research and analysis

The dollar is experiencing its worst monthly performance since January, down 1.85% across September versus a basket of currencies, despite there being a near universal expectation that the Fed will hike interest rates by 25 basis points, when it gives its monetary policy decision at 18:00 GMT on 26th September. Will the Fed reignite the dollar rally?

Fed turning more hawkish?
The US economy is firing on all cylinders, with economic growth at 4.2% on an annualised basis in 2018 and indicators are pointing to an even stronger Q3. All inflation measures are sitting at or around the Fed’s 2% target. Wage growth is on the up and unemployment is at a multi-decade low. The data is indicating that a third-rate hike is as good as in the bag. And its not just the data, Fed speakers are also supportive of tightening policy and moving towards neutral (seen at around 3%), leading the Fed funds to price in a 94% expectation of a hike tomorrow and a 76% probability of another hike in December.
3 hikes in 2019?

With broad expectations for 2 more hikes this year, the Fed to say that risks are roughly balanced and for projections to remain approximately the same, investors will be watching for any clues as to what the Fed is planning for the year ahead. The Fed has previously signalled that 3 hikes are expected across the course of 2019; the market is not up to speed pricing in these hikes which means that there is a good chance that we could see a hawkish hike, with Powell's objective to move the market up to speed with the Fed’s communicated path. The removal of the word accommodative from the statement would be a strong hawkish sign investors will watch for.

Fed to shrug off trade tensions
Up to now, the Fed has not shown any particular concerns over the escalating trade tensions. The big question for traders will be whether the Fed will alter its hawkish assessment of the US economy in light of the escalating trade spat and soften its outlook as a result. So far, the US economy has remained robust and up to now the Fed has shrugged off trade war developments preferring to see an impact from the escalating trade tensions on the economy before they change their path. The bottom line is that despite US – Sino trade tensions escalating the US economy continues to perform well, giving the Fed no reason that change their course. Should the Fed stick with this mantra to dollar could rally.

Market reaction:
Treasury yields are currently above 3% and trading at the highest level since May as market stands poised for Fed tightening.
The dollar is edging higher versus the yen ahead of the rate announcement and press conference. We expect the rate rise itself will have little impact on the dollar, given that it is as good as completely baked in. However, a more hawkish Fed trying to bring the market up to speed, could lift the dollar higher with USD/JPY looking to target 113.18, the high from July 19th or even look towards 113.50.

On the downside, any hints that the trade war will impact on US economic growth next year or dampen expectations of 3 rate hikes across 2019, the dollar could fall against the yen. In this scenario we would expect USD/JPY it to target 111.80 its 20-day moving average.

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