Will the Fed Acknowledge The Risks in the Economy?

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Market Drivers Jan 27, 2016

AU Inflation slightly hotter
Oil still roils markets
Nikkei 2.72% Eurostoxx -0.96%
Oil $30/bbl
Gold $1119/oz

Europe and Asia:
AU CPI 0.6% vs. 0.5%

North America:
USD New Home Sales 10:00
USD FOMC Meeting 14:00

Currency markets remained in a state of suspended animation awaiting the press release from today’s FOMC meeting due at 1900GMT but in the meantime weaker guidance from Apple and a drop in crude weighed on risk sentiment lifting euro to session highs at 1.0880 while commodity dollars yo-yoed up and down in morning European dealing.

Aussie was the one exception to the rule as the unit remained bid all night long after slightly hotter than expected CPU figures pushed it towards the .7050 level. Aussie trimmed mean CPI came in at 0.6% vs. 0.5% eyed as the rise in residential dwelling price inflation pushed prices higher, but as many economist have pointed out the most recent trend in residential dwelling prices in key markets like Sydney have fallen and that is likely to be a drag on price levels going forward.

In any case this is the second quarter in a row that CPI prices in Australia have fallen below RBA’s 2% band but the fact that they did not decline even further given the deflationary impact of lower energy prices was actually viewed positively by the market as traders assumed that the RBA will not ease further for the foreseeable future. Aussie popped all the way to 7051 before profit taking capped the rally, but the unit could see further strength if the FOMC meeting today proves dovish.

Although market participants don’t anticipate any action from the Fed, the press release will be heavily scrutinized for any signs of concern regarding the state of global economy. Since the last FOMC meeting capital markets have gone into a free fall and expectations for a March rate hike have been reduced to just 25% chance. Still we believe the Fed will remain as assiduously neutral as possible in order to give it enough latitude to hike in March should conditions improve. For that reason the FOMC may understate the recent downside risks in the economy and could disappoint traders who are looking for a more transparent, dovish assessment. Still if the Fed officials do acknowledge the heightened risks of further tightening, high yielders like Aussie could see a big pop from carry trade flows.

Boris Schlossberg
Managing Director

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