Daily analysis 16.12.2015

The main elements which are expected be analyzed during today's Federal Reserve meeting. How the US dollar may behave in the afternoon? The zloty pares some of the Tuesday's gains. Expected reaction on the PLN after the Fed's meeting.

Macro data (CET- Central European Time). Survey is supplied by Bloomberg unless otherwise noted.

• 14.30: Building permits in the US (survey: 1.15 million).
• 14.30: Housing starts in the US (survey: 1.13 million).
• 15.15: Industrial production in the US (survey: minus 0.2% m/m).
• 15.45: Preliminary PMI manufacturing reading in the US (survey: 52.6 points).
• 20.00: Interest rate in the US (survey: 25 basis points hike). Macroeconomic projections with the median Federal Reserve projections on future interest rate level.
• 20.30: Federal Reserve chairwoman conference after the FOMC meeting.

The key issues in the FOMC message

In the afternoon the Federal Reserve is expected to announce decision on interest rate hike. The decision is almost certain. It is a result from the comments of key FOMC members and economists' surveys. Moreover according to Bloomberg 102 out of 105 economists expected the Fed to hike the benchmark today. However, it is worth noting that this decision is very well communicated and should not be regarded as a surprise. As a result investors should focus on some other crucial issues.

Firstly the key message will be how the FOMC sees the future interest rate hike both in 2016 and 2017. In September the median Fed's expectation was 1.375% and 2.625% - which amounts to 4 increases next year and 5 more in 2017.

Taking into the account low inflation and no earnings pressure the median rate is expected to be lowered to 1.125 and 2.375 respectively. This view is also confirmed by the “Financial Times” survey where 40% of economists sees 75 bps increase after the December hike. The Fed fund rate should finish the next year in the range of 1.00-1.25%.

The above scenario may be regarded as a base one or even slightly dovish as a significant amount of economists (30% according the “FT”) who still claims that in 2016 there will be 4 hikes in the sum of 100 bps.

On the other hand if the median expectations is 2 hikes in 2016 (24% surveyed by the “FT”) then the dollar should markedly weaken. At this moment, however, according to us the odds for such solution are quite small. Even if the Fed really consider such scenario it is to early to suggest such shallow tightening as it closes the door for further modification if the economy performs at slower pace than expected.

Another element which may also be significant during today's meeting is the number of FOMC officials who dissent. If only Charles Evans, the Chicago Fed's president, fails to agree with the majority it wouldn't be a significant event. But if two governors – Brainard and Tarullo, join the dissenter's club it may suggest a stronger opposition regarding interest rate hikes in the Committee which may be more visible in the future decisions.

The final market reaction can also be strongly dependent on the FOMC statement and on comments from Janet Yellen. If the Committee notes a negative impact from stronger dollar on the export and inflation and the Fed's chief would suggest to analyze more the current than expected inflation then the comments should be regarded as dovish and may weaken the dollar after the FOMC decision.

As a result the dollar reaction may be volatile especially that there is a half hour gap between the statement and press conference from Janet Yellen.

The foreign market in few sentences

The main goal from the Federal Reserve today is to communicate the beginning of interest rate hike cycle and diminish any volatility. As a result the FOMC would probably suggest three interest rate hikes in 2016 and the statement will be mixed between encouraging comments on job market and some threats from low inflation pressure which should explain the shallow tightening path in the future.

It is possible that a significant part of the conference would be committed to strong dollar which diminish the US competitiveness abroad and reduces the inflation. This may be the catalyst, if other measures remain close to the consensus, which may slightly push the dollar lower after the FOMC meeting, and the EUR/USD could be pushed to around 1.10.

The sentiment improvement helps the zloty

Yesterday we observed a significant zloty appreciation. The EUR/PLN dropped even to around 4.30 mark. The main element which improved the sentiment on the zloty was a solid day on developed capital markets. The move on the zloty was also confirmed by the behavior fixed income instruments. Yields on 10-year Polish bonds dropped 20 bps to 3.1% while the spread between Polish and German papers dropped from the highest levels since mid 2014.

Theoretically the monetary tightening should be negative for the EM currencies. However, much of the move should already by priced in. As a result the reaction should be fairly muted if the Fed's statement doesn't surprise significant.

However, in case of very dovish stance (2 hikes in 2016) from the Fed it is expected that the EUR/PLN may even drop below 4.30 and the dollar slides to around 3.90. On the other hand if the Fed plans to keep 4 hikes next year the EUR/PLN may even rise above 4.35 and the dollar could return to 4.00 mark.

Anticipated levels of PLN according to the EUR/USD rate:

Anticipated GBP/PLN levels according to the GBP/USD rate: