Dollar loses no ground against the Euro, despite FOMC interest rate decision
21/Sep/2015 • Currency Updates•
All eyes were on the FOMC meeting last week. The Federal Reserve left rates unchanged, as markets (but not economists, including ourselves) had been largely expecting. Messages from the statement and Chairman Yellen’s press conference were mixed, but made it clear that the US central bank is looking at financial markets with some concern for the first time in many years and that had perhaps been the decisive factor in their decision to hold rates.
The reaction from currency markets was somewhat surprising. After rallying sharply in the aftermath of the decision, the Euro gave up all of its weekly gains late Friday to end up nearly unchanged against the US Dollar. Sterling managed a modest rally and emerging market currencies mostly suffered on Friday but still rallied off their lows, which we have been calling for a couple of weeks now.
The ILO labour report underscored the significant tightening the job market has undergone over the past few months. The average three-month rate resumed its drop to 5.5%, while the single-month rate dropped further to 5.4%. Even more importantly was the acceleration of real pay growth. Including bonuses, it is growing at a nearly 3% annualised rate, which puts it roughly 2% above core inflation – one of the fastest rates of increase in real compensation anywhere.
While the Fed failure to hike interest rates has clearly increased the risk of a delay by the Bank of England, positive developments in the labour market and a still buoyant housing market lead us to maintain our call for a February 2016 hike. While interest rate markets are predicting a later increase, the good news last week was enough to send Sterling modestly higher against both the Euro and the US Dollar.
Last week was marked by an absence of significant Eurozone-wide data releases or policy decisions, and markets rightly focused on the FOMC. Such news as there was, was mostly positive. Industrial production rose 0.6% in July, offsetting the June 0.3% fall and leaving this index on track for a roughly 1.5% increase in the third quarter. News from the consumer side (retail sales, car registrations) were similarly modestly positive and leave third-quarter growth on track for a rise of 1.50%.
However, the FOMC decision not to raise rates makes it all the more likely that the ECB will announce an expansion of its QE program before the end of the year. Markets certainly seem to agree, as the initial sharp gains in the Euro after the Fed decision were completely dissipated in trading action over the following 24 hours.
Economists were split roughly 50/50 on the FOMC decision, although rates markets view was only for a 30% probability of a hike. In the end, the FOMC opted to keep rates unchanged at their current 0.25% level, with just one committee member, Jeffrey Lacker, voting to increase rates in September.
The accompanying monetary policy statement was also moderately dovish. While the Fed acknowledged the domestic economy was healthy and performing well, downside risks from abroad continue to provide a drag on the economy. The Fed is clearly more concerned about overseas risks than we had anticipated and now appears to be looking more closely at the stock market; something that it hasn’t done for years. Chair Janet Yellen also reiterated the need for “some further improvements” in the labour market and increased confidence that inflation would return back to its target.
However, critically, the Fed’s infamous “dot plot”, which represents where each committee member expects interest rates to be in the near term future, shows that thirteen of the fifteen FOMC members still expect a rate hike to occur in 2015. This means that an interest rate hike in 2015 is still most certainly on the cards.
Given this, and considering that at the press conference Janet Yellen kept the door open to a rate hike next month, stating that it was very much a “live” meeting, we now see a 50/50 chance that the Fed will hike at either the October or December meeting. This forecast is conditional on no negative surprises abroad or in the stock markets, such as last month’s ‘Black Monday’.