Fed hikes and retains hawkish bias

As widely expected, the Federal Reserve raised the target range for the Fed Fund rate from 1.75% – 2.0% to 2.0% – 2.25% following last week’s FOMC meeting. It means that the Fed has now hiked rates three times in 2018 and remains on course for a fourth in December. The fact that the market is pricing a December hike with a 77.2% probability compared to 77.7% prior to last week’s events tells us very quickly there was nothing unexpected in either the decision itself or Powell’s accompanying statement.


That slightly undersells last week’s statement where there was in fact one notable change. Powell omitted the statement “The stance of monetary policy remains accommodative, thereby supporting labour market conditions and a sustained return to 2 percent inflation.” This suggests that the Fed sees policy gradually becoming ‘more normal’ and could be an indication that we may not see rates continue to rise at such a pace going into 2019. However, Powell was quick to play down the significance of the change and noted that it “does not signal any change in the likely path of policy.”


The challenge for the Fed now, is how they avoid applying the brakes too hard thereby causing the recent economic expansion to stall, or worse still, start to decline. As a result, we are left to ponder about what we can expect for US rates in 2019. It’s been well documented that the US yield curve is considerably flatter than it was twelve months ago reflecting expectations that the Fed won’t continue to tighten policy as aggressively in the years to come. According to the Fed funds effective rate, there is just a 21% chance of another four (or more) 0.25% rate increases in 2019.





This is a key reason why we are becoming increasingly cautious about our USD bullish bias as we head into the end this year and look forward at 2019. When combined with Trump’s protectionist policies and a strong desire not to see US manufactures disadvantaged compared to their Chinese or European competitors, we could easily be getting close to a turning point for the dollar.


With the US economy growing at an annualised pace of 4.2%, inflation running at 2.7% year on year and unemployment close to record lows at 3.9%, there appears a strong argument for the Fed to deliver a hawkish surprise and continue raising rates in 2019 at a similar pace to what we’ve become accustomed to in 2018.  If this were to transpire, it would also certainly result in the dollar advancing further against all its major counterparts, particularly in the short term, as investors seek higher yield.  


A final factor worth considering, particularly from a short-term perspective, is market positioning. According to the latest data from CFTC, the market is building increasingly large short GBP, EUR and JPY positions. While there is certainty still room for these positions to grow further, at least by historical standards, we know from experience that the larger positions grow, the greater the risk of an exaggerated move when they are unwound.   



Marc Cogliatti


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