Market Watch

Looking ahead to this week’s Fed meeting and higher interest rates, with Market Strategist Evan Lucas.

Are we about to see the start of a faster and stronger rate trajectory?

Momentum for the March 2018 Federal Open Market Committee (FOMC) meeting has been building since last December. Since then, the Fed has ushered in a new Chair, new voting members, green shoot signs in inflation, employment at ‘full’ capacity which has seen wage inflation ramp up, and a huge round of fiscal stimulus in both tax cuts and government spending. Everything is lining up at the world’s largest central bank to not only set the case for raising rates, but to ditch the gradual rises and go to a regular interval.

Market pricing suggests, and surveyed economists agree, there will be another rate rise at 5am (Australian Eastern time) Thursday morning. This would mark the first time in 19 years the Federal Funds Rate overtakes the Reserve Bank of Australia (RBA) cash rate.

This chart gives a clear picture of what happened to the Australian dollar when this last happened.

As the chart illustrates, when the differential between the Australian 10-year and the US 10-year shifts to positive, the carry trade flows to the country with the higher yield – in the main, the Australian dollar. However, with US 10-years set to overtake this week, the question arises as to whether it will eventually become a situation like 1998-2000 where the Australian dollar was as low as 48c.

This is an interesting one when it comes to winners and losers. US dollar-denoted earners would benefit – exporters and other firms that repatriate monies back into Australian dollars. However, you only need to glance at our current accounts to see that Australia is a net importer of capital. Foreign direct investment is a major economic driver for Australia, and if projects start to suffer forex headwinds, then foreign direct investment will slow.

Now, back to the Fed meeting. The market is uncertain about what will happen if the Fed's dot plots shift to the left: 

Below is the December dot plot for the Fed. We would see the market reprice debt and risk markets if the 2018 column shifted higher, as the red line demonstrates. That would signal the Fed moving to a more hawkish stance and the expectation of four rate rises in 2018. 

Although a touch old, here are the voting intentions of the Fed board:

As you can see, there are plenty of holes in the voting core of the board. When you factor in that New York Fed President, Bill Dudley, is stepping down in June, the holes become even bigger. For these reasons and others, there is so much at play on Thursday – the meeting will set the tone for most investment and trading in 2018.


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