Thoughts ahead of the FOMC

As we approach the Fed meeting announcements tomorrow, what stands out most is that the make-up of the Fed is likely to change significantly next year making the Fed’s projections more meaningless than usual.  Furthermore, there is significant uncertainty over what stance the Fed might adopt next year, leaving policy more uncertain.

It seems very likely that the Fed will launch QT and it has set out a very well articulated plan for this.  This is probably the last gift of the Yellen-led Fed to the American economy before the Fed goes through a shake-up.

It does not appear that President Trump has a clear plan to shape the Fed.  He has nominated Randy Quarles for a Board position which suits his agenda to roll-back regulation on the financial system.  This might be seen as good for banks and credit growth.

Quarles is also thought to favour a more rules-based monetary policy, which fits with a Republican vision of the Fed.  On the other hand, more rules-based monetary policy might lend itself to higher rates and faster QT.  This would seem to not appeal to Trump that says he likes low-interest rates.

Another candidate said to be favoured by Trump/Republicans in Marvin Goodfriend.  He too supports a more rule-based approach to monetary policy.

The move towards these two candidates represent a Republican vision of the Fed, and away from the type of Fed Yellen has championed.  Her vision of a highly academic Fed, with less rules and more control of banks is under threat.  Her creed appears on the way out, and thus she may no longer want to Chair the Fed, even if Trump might like her more cautious approach to monetary policy.

Gary Cohn, the President’s economic advisor, has on and off been rumoured to be the preferred candidate for Fed Chair.  But it is very unclear who will be the Chair and Vice-Chair at this point.

The rotation of Presidents will remove too pretty clear doves (Evans and Kashkari) and a hawk Mester and a leaning-hawk in the last year (Williams) will move in.  The other two rotations appear to be a bit of a wash with centrists out and two unknowns (Mullinix and Bostic) in.

It might seem that the new potential board members (Quarles and Goodfriend) and the President rotations will appear more hawkish.  But the bottom line is that the leadership on the Fed and its direction on monetary policy are an unknown.

In guessing the Fed dot-plot for tomorrow,  It seems unlikely there will be any change to the unemployment and growth outlook, but some chance that inflation is revised down; although unlikely.

We may see some move down in the rate dots, but probably not sufficient to meaningfully lower the median dot points.  Considering the market is mixed on the hike at year-end, and has less than two hikes priced in by the end of next year, we don’t see much scope for rates to fall on this Fed meeting.

We expect the FOMC to adopt a steady she goes outlook, not much different from the July statement.  It is likely to say again it is monitoring inflation developments closely.  This may sound dovish, but should be expected.  Yellen should sound out that the hurricane effects should not impact the broader trajectory of the economy, anticipating softness near term ahead of stronger activity early next year.

We bought USD/JPY and GBP/JPY ahead of the FOMC largely on the prospect of more focus on tax reform, a more deal-driven President, less immediate threat of NK theatrics, possible shift in focus towards QT potential steepening impact on yields, stronger global growth confidence and strong asset markets generating higher inflation expectations globally.  We are not looking for any surprise from the FOMC on rates.

USD/JPY dipped today into and during Trump’s address to the UN, where he called the NK leader “rocket man” on a suicide mission.  And he said he is ready to destroy NK, but hoped UN actions would not make this necessary.  He also was highly critical of Iran.

Such talk, justified or not, may evoke some response by NK and poses a risk to the short JPY trade.

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Greg Gibbs,
Founder, Analyst and PM
Amplifying Global FX Capital Pty Ltd