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RESEARCH NOTE: US FOMC Preview
Brian Dolan, Chief Currency Strategist
Jacob Oubina, Currency Strategist
Summary Outlook:
(Monday, August 4, 2008) We expect the Fed to stay on hold when they announce their interest rate decision on Tuesday, Aug. 5 at 1415EDT/1815GMT, which is also the consensus market expectation. The FOMC statement is likely to retain much of the same language as the June statement, so this may turn into a non-event. But the risk is that the Fed highlights renewed downside risks to the US outlook, reigniting fears of a US recession still to come. It will be a question of 'tone'-have things gotten better, worse or stayed the same (weak)? We continue to favor buying USD on dips, as slowing global growth is undermining demand for commodities and reducing overall USD selling interest.
Market Impact:
Should the Fed indicate a bleaker US outlook, we would look for the USD to come under selling pressure, but view this as an opportunity to re-buy the USD on dips/re-sell EUR/USD and GBP/USD on bounces. Specifically, we would look to sell EUR/USD in the 1.5730/80 area and GBP/USD between 1.9800/50. We would steer clear of USD/JPY and the JPY-crosses in this environment, as the impact on the JPY-crosses and risk sentiment is unclear.
Analysis:
Economists are largely forecasting rates to remain on hold at 2.0%, with only a few calling for a 25 bps increase. The futures market meanwhile is pricing in a measly 7% likelihood of a rate hike, and thus the "bets" are heavily skewed to a Fed on hold as well. We would concur that the rates will remain unchanged at 2.0% next week and for the foreseeable future. The Fed remains handcuffed by weak economic activity from an ongoing credit crunch and uncomfortably high inflation. The accompanying press statement will probably see little change from the June 25 communique. The key will be whether they leave in the phrase that "the substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time." This would suggest that the Fed views the current level of rates as appropriate and suggest to the market they plan to remain on hold.
Dallas Fed President Fisher is likely to dissent again and favor of an immediate tightening, and he could be joined by Philadelphia Fed President Plosser, which would likely lead to a quick pop higher for the USD, but ultimately be discounted. Should Fisher not dissent, it would be taken as an indication that he foresees even greater US weakness ahead amid a steeper global downturn, and this would likely result in the worst USD-scenario, but not alter our bias to buy USD's on selective weakness.
Our rationale for buying the USD on dips is that global growth is slowing and the outlooks for Western Europe and the UK, in particular, have dropped sharply in recent weeks. We think the market still has yet to fully 'price out' the chances of rate hikes from the BOE and ECB, much less 'price in' likely rate cuts. Slowing global growth is also undermining demand for raw materials and commodities, especially oil, and lower commodity prices reduce USD selling interest.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
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