Market waits for Fed (Daily analysis 21.03.2018)

21.03.2018 09:14|Marcin Lipka

Tuesday's session supported the dollar, which may decrease the US currency appreciation scale even in the case of a relatively hawkish statement from the Fed. The Fed's message will also be important for the zloty.

The most important macro data (CET - Central European Time). Surveys of macro data are based on information from Bloomberg unless noted otherwise.

  • 7.00 p.m.: Decision on interest rates in the USA (estimates: increase by 0.25 percentage points to the range of 1.50-1.75 percent). Publication of the statement, macroeconomic projections and estimates of future rate hikes,
  • 7.30 p.m.: Press conference of Jerome Powell, the President of the Federal Reserve.

Stronger dollar

During Tuesday's session, noticeable increases in the US currency occurred. The dollar index (DXY) rose by more than half a percent and the EUR/USD dropped by around 100 pips. Movement on the dollar was also confirmed by changes in the US Treasury bond market. Yields of 5-year debt instruments reached the level of 2.7%, i.e. the highest values in 8 years.

The interest rate market estimates that by the end of the year (together with today's decision) the monetary policy will have been tightened to 0.85 percentage point, which means that the market is practically divided into 50:50 about whether there will be three or four increases of 0.25 percentage points in 2018. However, the question arises whether the Fed will follow the flow and suggest a tightening of as much as 1 point this year?

There are many arguments to speed up the pace of rate hikes. A strong, pro-cyclical fiscal stimulus in the US is visible. The economy will grow well above potential in the next two years. The risk of its overheating, and therefore more rapid slowdown in the future, is growing. This is an argument for a faster pace of increase this year.

The number of voting FOMC members is also changing (to more hawkish, especially in regarding the representatives of the Fed's regional branches). Moreover, Lael Brainard's stance has moved towards a more restrictive approach, which is also significant, especially as it is a member of the Board of Governors.

On the other hand, the suggestion of four rises minimizes the room for the Fed to react to unpredictable events. Moreover, the path of future inflation is still a great unknown to the Federal Reserve, although in the last minutes it was clear that not only the members of the Fed but also the economists are increasingly convinced that it will approach the central bank's target.

Therefore, it will be safer to keep the median of increase at the level of three unchanged this year but to raise the number of increases from two to three for next year. Probably, this would weaken the dollar at first (given yesterday's strong appreciation). However, it seems that the higher inflation projections and the relatively hawkish message at the conference should ultimately support the US currency, cause further increase in yields on the US government bonds and worsen rather than improve sentiment on the New York market.

Zloty under Fed pressure

Due to the stronger dollar, the USD/PLN exceeded the 3.45 level, i.e. reached the highest value in over two months. The valuation of EUR/PLN pair remains close to four-month highs. However, the high EUR/PLN exchange rate is caused by the recent dovish MPC and lower inflation readings from the country rather than the situation in the world.

Today's Fed message should be hawkish, but the chances for the Fed to announce four increases this year remain rather limited, even if, the US monetary policy ultimately increased the cost of credit by 1 point this year (see previous paragraphs). Therefore, giving yesterday's dollar strengthening, the first reaction of the market may be relatively calm, if not negative, for the USD. However, later on, when investors see that FOMC is generally hawkish (a change in macroeconomic projections, a press conference, three increases in 2019), a stronger dollar and a weaker zloty compared to most major currencies should be seen.


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See also:

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