Detailed analysis: What’s behind the Federal Reserve decision?

Enrique Díaz-Álvarez29/Oct/2015Currency Updates

As was widely anticipated, the Federal Reserve once again opted to keep its benchmark interest rate unchanged at 0.25% on Wednesday night, following the end of the Federal Open Market Committee’s (FOMC) two-day October monetary policy meeting.

However the door has been left firmly open to a rate hike at its next meeting in December. While unsurprising, the US Dollar was sent higher against its major peers, making strong gains against the Euro.

The sole dissenter

There were no major surprises in the Federal Reserve’s statement. Jeffrey Lacker once again remained the sole dissenter by voting for an immediate rate hike. US policymakers acknowledged that the pace of US job creation had slowed and unemployment remained steady.

News from abroad

Importantly, while the central bank will continue to monitor economic and financial developments abroad, it removed the line from the previous monetary policy statement that suggested global developments could restrain US economic growth. This represents a distinct softening in tone from last month’s rhetoric.

Our expectations

Critically, the Federal Reserve remains consistent with our expectations for a data-dependent December interest rate hike. They suggested that, for a rate hike to occur, there would need to be further improvement in the labour market and reasonable confidence among policymakers that inflation will gradually move back towards its target.

We remain of the opinion that the Federal Reserve will finally begin its monetary tightening cycle at its next FOMC meeting, on 16th December. Interest rates have now been frozen for the past seven years in the US, however, robust economic growth and an improvement in labour market conditions, in our view, warrant a raise in rates.

Markets now appear to be in agreement with this view, with pricing for a December hike consequently spiking to its highest level since mid-September at just shy of 50%.

Importance of payroll figures

This forecast for a rate hike in 2015 remains dependent on no negative surprises in the level of job creation at the next two labour reports. Nonfarm payrolls, in particular, need to increase back to above the 200,000 a month level.

Therefore the release of nonfarm payroll figures on the first Friday of both November and December take on added importance and will, in our opinion, be crucial to the short term evolution of the US Dollar.

Impact on the Dollar

The relatively hawkish statement by the Federal Reserve sent the US Dollar sharply higher against the Euro by 1.5% (Figure 1), and by 0.5% versus the Pound (Figure 2), and should provide good support for the Greenback between now and the next labour report.

Figure 1: Intra-day EUR/USD (29/10/2015)
Federal Reserve

Source: Thomson Reuters Date: 29/10/2015

Figure 2: Intra-day GBP/USD (29/10/2015)
Federal Reserve

Source: Thomson Reuters Date: 29/10/2015

An interest rate hike in 2015 will provide strong long term support for the US Dollar against almost all of the currencies major counterparts. Given the European Central Bank is expected to announce an expansion of its existing 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.