The Fed Can’t “Err Dovish”

For those of us who just can’t get enough when it comes to analysis of today’s Fed meeting (and likely hike) and what the FOMC plans to do when it comes to making sure forward guidance is in some sense “in sync”  with what Trump’s stimulus plans will mean for the economy and inflation, I bring you the latest missive from Deutsche Bank’s Alan Ruskin, who speculates a bit on what a dot shift would mean for the USD.

From Deutsche:

A Fed rate hike at the Dec FOMC meeting is a foregone conclusion. The market has already leapt ahead and is focused on the forward looking aspects of the FOMC news flow: the dots; the economic forecasts; and the indications from Janet Yellen, on how much weight the FOMC puts on ‘animal spirit’ inspired growth, and prospective fiscal expansion. As a starting point, it’s hard to see how the Fed can err dovish. The most dovish actions will come from ‘omission’ — from saying very little, which is not apt to rankle markets much. The Fed taking a cautious line makes sense, because the market is not so hopelessly mispriced for the coming meeting that it needs any immediate guidance, and, because subdued inflation does give them some time to gather more detail on the actions, scale and timing of the likely fiscal expansion. Nonetheless, there is likely to be more FOMC willingness to entertain an acceleration in tightening. While the January meeting will need a very special December payrolls number for them to hike, March must be considered genuinely ‘live’. Secondly, it is going to be impossible for the Fed to “run the economy even hotter” in the face of a pending fiscal stimulus, or they risk being caught way behind the curve. In that sense, the preelection flirtation with more extreme dovish thinking is likely over. As we look to post-meeting market reaction, the first response will likely be on the dots. If the end 2017 median dot shifts up (two dots at 1- 1.25% moving higher by 0.25% will do it) this is probably worth some 0.5% or a little more on EUR/USD and say 1% higher on USD/JPY that will probably be most responsive to any hawkish signals. No change at all in the dots might be seen as mildly USD negative (EUR/USD uptick by ~0.5%), but this is a USD dip that will be quickly bought. Most participants will take a view that there is some built in ‘dot inertia’ until more details on the fiscal package are known. Next in importance for the FX market is likely to be the economic forecasts and the unemployment rate forecasts in particular. Given the recent drop in the U3 rate to 4.6% which is already below the FOMC’s median longer-run 4.8% NAIRU proxy, the new FOMC unemployment rate forecasts are apt to affirm Taylor Rule projects that a marked acceleration in tightening is already needed, and suggests the Fed has already run the economy hot.

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