US FED Policy: Will Powell confirm Dollar Top?

US FED has been effectively using forward guidance tool, better than other major central banks. US FED is likely to hike interest rate by 25 bps to 2.25%-2.50% range tomorrow, 19 December. Global markets have broadly priced in this hike and will be more concerned about forward guidance.

As per last FED Dot plot projections, released on 26^th September, US FED was likely to hike interest rates 3 times in 2019. A lot has changed since then, Equity markets are now in a tight grip of risk off sentiments as S&P 500 index has turned negative in the current year with more than 12%, from September levels, to 2545 levels. The Crude prices have also reversed the up-trend as prices tumbled nearly 29% in three months from 82.72 in Sep to 58.73 levels, Consequently, US treasuries surged during the period as 10 year yield fell nearly 7% to 2.84%.    

	Week End 28 Sep	18-Dec	Change
Crude Oil	82.72	58.73	-29.00%
S&P 500 Index	2913	2545.94	-12.60%
US 10 Year	3.05%	2.84%	-6.89%
US Dollar Index	95.13	97.11	2.08%

Table 1: Key Asset Prices

US economy

Despite a significant correction on Wall Street, underlying US economy yet to show major signs of concerns. Retails sales grew by 0.2% in Nov-18 and Sep reading revised upwards to 1.1%. ISM non-manufacturing PMI remained over 60 levels. Labor market data painted a mixed picture as unemployment remained near multi-year low of 3.7%, but wage-growth slowed to 0.2% against 0.4% in September. 

Powell’s Tone

Another development has been in change tone of Jerome Powell, FED Governor. In a recent speech, Powell mentioned that US interest rates are just below neutral rate, a rate at which it neither hold growth nor aid it. Although, we can be tempted to attribute this change in stance to Trump Tweets, but a closer look at inflation numbers, crude oil prices and slowing global growth shows that Powell has enough reason to turn a bit dovish at current junction. It is note-worthy that post rate hike tomorrow, Spread between 10 year bond yields and FED fund rate might fall to 30 bps, close to decade lows. Such low spread, clearly indicate that Bond market is not painting a pretty picture, might be pricing sustained low inflation in US economy. 

                                                 Spread: US 10 Year bond and US FED interest rate

As shown below, Market is pricing a rate hike tomorrow and another single rate hike in 2019 against three rate hikes suggested by FED’s September dot plot. Given current economic backdrop, it is expected that FED might project less rate hikes in 2019. This change in stance, should ideally result in softer Dollar theme after US FED policy.

                                                      Rate Hike Probability: For 11 Dec-2019

The US Dollar index is currently trading near 97.00 handle will see significant resistance levels 97.80-98.00 levels and near term support at 96.20-96.30 levels. A break below 96.20 levels should pave the way for 93.80 levels.