The FOMC concludes their two-day policy on Wednesday and while no change in Federal Funds Rates is expected, we could see a cut delivered on the interest on excess reserves rate (IOER), which would be more of a technical adjustment that could prompt an initial wave of dollar selling. Traders will closely watch the Fed’s reaction to the impressive first-quarter GDP numbers and dismal inflation releases. Expectations are almost at a coin flip that the Fed will cut interest rates at the September meeting.
- Fed to hold rates steady; possible cut to IOER (technical adjustment)
- Will they set the table for a rate cut over the next few meetings
- Possibly hint at new repo facility to help the policy transmission mechanism
The dollar got crushed after the last FOMC rate decision, albeit the weakness only lasted a day. If we do see a strong dovish outcome, combined with the recent uptick we’ve seen from the euro zone, the dollar could be poised for a major reversal here. Volatility has been nonexistent for most of the major currency pairs in FX, but if the Fed sticks to the script of patience and becomes determined on tackling soft inflation, we could finally see some sustained moves.
The Fed will have to tweak their view that the economy has slowed since the last meeting and they will likely emphasize concern with low inflation. The Fed’s preferred inflation metric printed at 1.3% in the first quarter, well below the Fed’s 2% inflation target. Since the March meeting, downside risks appear to evaporated as the economy grew 3.2%, although much of that gain is being attributed to private inventory investment, net exports and government spending. The Fed will have a tough few next meetings, but they should stay to the script and remain on hold until they can see how the second quarter unfolds. They may not have the patience to wait on addressing the soft inflation and they could tee up a rate cut to occur before end of summer.
Policymakers will also have to debate the effects that the balance sheet runoff is having on their policy transmission mechanism. They may wait until quantitative tightening is over, but they may need to create a new repo facility, which will help banks borrow at the top of the policy target.
The dollar is at a critical juncture and we if we see the Fed maintain their full-dove mode, we could see high-beta currencies and commodities gain a strong bid.
What the Top Banks/Research Teams are saying about tomorrow’s FOMC meeting:
JP Morgan’s Chief Economist Kasman: I think they stay on hold here for a long time, but there is a risk that lower inflation does push them to think about easing.
JP Morgan’s Economist Feroli: If the funds rate continues to trade near recent levels, we think there’s about one-in-three chance they make another 5 (basis points) technical adjustment to the IOER rate.
SocGen’s Head of US Rates Rajappa: The Fed could emphasize the positives on the economy, but I’m just not sure how they can meaningfully move the needle on the rates market.
Standard Chartered US Economist Meskin: We do not expect a cut to the IOER, the rate of interest the Fed pays banks on excess reserves, in May. However, we do expect the Fed to acknowledge recent money-market volatility, including the overshoot of IOER by the effective fed funds rate (EFFR) – the first since the IOER was introduced in October 2008. These moves were likely temporarily exacerbated around the April 15th tax deadline and should abate in the coming weeks.
Morgan Stanley Strategists: We believe the move higher in EFFR comes as a surprise to the Fed and most market participants since there has been a belief that at current reserve levels EFFR is likely to remain sticky close to IOER.
MarketPulse VP of Market Analysis Popplewell: Feds integrity is at stake here, Chairman Powell needs to reiterate his recent dovish stance otherwise the Fed will lose some degree of respect from the street. I expect a September cut to be baked in sooner than later.
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