FOMC expected to keep interest rates unchanged in October

Enrique Díaz-Álvarez27/Oct/2015Currency Updates

US policymakers have gathered in Washington this week for their October Federal Open Market Committee (FOMC) meeting to decide whether the time is right to begin their long awaited monetary tightening cycle.

The Federal Reserve has kept interest rates unchanged for the past seven years at essentially zero but, as the unemployment rate falls closer to their definition of full employment, markets are bracing for a first rate increase. The key question is, when will it happen?

Robust economic growth

US economic growth printed an impressive 3.9% in the second quarter. Job creation, despite dipping earlier in the month, has been on a gradual path of improvement, while unemployment is currently at its lowest level in six years.

However, the chances of a Fed interest rate hike being announced this Wednesday evening are very low. Interest rates markets are pricing in less than a 5% chance of an interest rate hike.

Disappointing labour data

The main reason for this is of course the disappointing labour report released at the beginning of the month, which, in our view, all but ruled out an October hike. The report was a major disappointment, showing that the pace of job creation had slowed to below 200,000 for the past four months (Figure 1).

Figure 1: US Nonfarm Payrolls (2010 – 2015)
Figure 1 US Nonfarm Payrolls (2010 2015)

Source: Thomson Reuters Datastream Date: 27/10/2015

Wage growth also slowed noticeably, while labour market participation dropped to a new cycle low.

Inflation woes

This situation is compounded by the US inflation figures, which remain persistently low, having fallen back below zero in September (Figure 2).

Figure 2: US Inflation Rate (2012 – 2015)
Figure 2 US Inflation Rate (2012 2015)

Source: Thomson Reuters Datastream Date: 27/10/2015


What to watch for: Monetary Policy Statement

As always, attention among traders will be on the Fed’s crucial monetary policy statement, which will be released alongside the interest rate announcement at 6pm GMT on Wednesday.

The tone of the statement will likely be the main driver in the currency markets. We expect the statement to be fairly non-committal and outline that a hike in December will be dependent on incoming data.

A more hawkish statement, one that downplays recent weak economic data and opens the door to a December interest rate hike, would likely provide good support for the US Dollar this week.

However, we also acknowledge the possibility that the FOMC could err on the dovish side, instead emphasising the uncertain economic outlook and providing no clear indication of a December lift-off. This could, in contrast, cause a short term weakening of the Dollar against most of its major peers.

Further dissenters?

Another critical piece of information will be whether any other dissenters join Jeffrey Lacker in voting for an immediate hike. We have heard hawkish noises from the regional organisations of the Fed, 8 out of 12 of whom have requested an increase in the discount rate. However, the power of the regional Banks within the Fed is rather limited and this request is mostly symbolic.

Our call

We maintain our call for a Fed rate increase in 2015 at the December FOMC meeting. This forecast assumes that payroll growth over the next two labour reports will return to the 200k+ levels we have been accustomed to.

Future Dollar strength

When the Federal Reserve does begin hiking rates, the gradual process should provide good long term support for the US Dollar against almost all of the currency’s major peers. Given the ECB is expected to announce an expansion of its quantitative easing programme in December, we should see Dollar strength against a much weaker Euro.


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Written by Enrique Díaz-Álvarez

Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.