Has the Battle of the Dollar Begun?

Has the Battle of the Dollar Begun? Feb 1st

As we go into FOMC today, the market is preparing for a battle. Since Donald Trump’s election in November the prospect of inflationary growth and consequent Fed tightening has driven the US dollar higher. However more recent political rhetoric from the new administration has weakened the USD as President Trump seeks to regain a competitive advantage for the US. As the Fed, on the other hand, is responsible for controlling inflation (and employment) with now higher interest rates and other monetary tools, Donald Trump is not helping them to their job. Could today’s FOMC meeting therefore produce “a shot fired that was heard around the world”? We think not. As the US is still in a phoney war.

We believe this will be a recurrent and growing theme throughout the year. The Fed Chairman Janet Yellen’s bid to keep inflation in check with higher rates will support a Dollar that Donald Trump seeks to weaken to make the United States more competitive against previously weak(ening) currencies. In, short, an inflation versus devaluation Dollar. This continuous shifting in the market’s focus between a weak and strong USD suits our view of a slow whipsaw turn led more by growing inflation elsewhere than a politically neutered greenback.

A weakening USD and a stuttering bull stock market sets the scene for today’s interest rate decision.

Only six weeks after the 0.25% rate hike at the December meeting, it appears only 25% of the market is expecting a rate hike by March 2017. With no press conference and a high probability of no rate increase today, attention will be focused on the statement. This is particularly the case after the last meeting’s change in the dot plot when the FOMC perhaps surprisingly indicated its intention to raise rates a faster rate throughout the year to forestall Trump inspired inflation. Janet Yellen was at great pains to insist they are not behind the curve.

We can expect two things from the statement:

1. No change in Fed outlook as it remain evenly balanced both from an economic and political standpoint. Moderation in recent economic performance (evidenced by the recent GDP miss) and only a modest increasing in inflation will give little cause to adjust the dot plot. It would look foolish to change things only a month after particularly as inflation appears still to be heading towards target over the term. The language of the statement may well change from ‘accommodative’ monetary policy to a slightly more dovish ‘modest’. However the Fed is likely to sound constructive on economic growth projected to be 2.9% in 2016. Previous meetings in 2016 have held the Fed back from raising rates due to concerns over both China and Brexit. But with no such apparent geopolitical risks to the fore it will barely raise a mention. We also doubt there will be much if any reference to the new administration’s fiscal policy so early in the Trump presidency when the extent of his fiscal expansion is unclear. However this may change later in the year if an inflationary Trump inspired weaker Dollar combines with an even greater inflationary increase in government expenditure that is not financed by tax. The tug of war over inflation and USD could begin.

2. The markets will therefore move based more on current trading positions and expectation than anything in the statement. At MatrixTrade, we continue to track how markets move into such events particularly so we can benefit from a consequently predicted move after the event. It is interesting that there is often a noticeable difference between statement only meetings and those with press conferences. This is mainly due to lower expectations of anything dramatic from a statement only meeting but also that the reaction tends to be faster than in a nuance by nuance delivered press conference.

This is what the FOMC fractals are currently saying on two of the markets we follow.

USD Index (DXY) FOMC Fractal

US Stock MARKET FOMC Fractal (SPX)

Subscribers to matrixtrade.com can see how the recent price action is following FOMC fractals on these and a wider range of markets including EURUSD USDJPY and the most consistent FOMC performer, Gold.