Market analysis: US hawkish but Federal Reserve may hold back hike

Financial markets remain volatile in the lead-up to the Federal Reserve’s interest rate decision on Wednesday even as investors expect rates to remain unchanged.

Market participants have shown a heightened level of sensitivity to key releases from the US data docket, which continues to swing expectations of future Fed action.

The CME Group’s FedWatch tool indicates probability of a rate hike to 50 to 75 basis points at 12 per cent for this month, increasing to 45.2 per cent for December. The closely watched FedWatch tool allows investors to view the probability of Fed rate moves for upcoming meetings based on the CME Group’s 30-Day Fed Fund futures prices. The CME Group is one of the world’s largest operators of derivatives and futures exchanges, with operations in Chicago and New York.

While we have maintained that the Fed will adopt a wait-and-see stance at least until December, we can expect stronger hawkish undertones from the US central bank because of what is perceived to be an improving US economy.

While the numbers have not been outstanding, there has been a general strengthening across the core figures, which may give the Fed a more hawkish licence. US inflationary data (one of the key components dictating Fed policy) improved in the latest readings released last Friday.

Consumer prices in August expanded to 1.1 per cent from 0.8 per cent year-on-year. Jobs growth was slightly down last month, however the three-month average sits at 232,000 which will give the Fed added optimism. Home sales have held on to their gains and while manufacturing PMI dipped below expansionary levels in August (49.4 actual versus 52.6 previous), second-quarter GDP was in line with expectations at 1.1 per cent.

We expect currency and commodity markets to remain in very tight ranges in the lead-up to the Federal Open Market Committee meeting, which will release its statement at 10pm UAE time on Wednesday, after which we expect to see large swings as volatility will remain elevated through Fed chairwoman Janet Yellen’s speech, which will commence at 10:30pm.

Mrs Yellen’s overall hawkish view on the current state of the US economy should lend support to the dollar in the short term, which should result in the greenback closing the month higher against other currencies and commodities.

And since this meeting falls at the end of the third quarter, the Fed will also reveal its economic projections.

Released once a quarter simultaneous to the rate decision, the economic projections are a good insight into the Fed’s views on the trajectory of the US economy.

The last release at the end of June showed that the Fed expected a slowdown in overall output in 2016 and 2017, but it also expects stronger inflation through the same period. We can expect to upgrades to its projections, particularly to the 2017 and 2018 outlooks.

With the dollar expected to close the month on the front foot, that leaves the currency majors vulnerable to further downsides against the greenback.

We had the rate announcements from the European Central Bank and the Bank of England – and as expected both were unchanged. The ECB’s Mario Draghi and BoE’s Mark Carney will await more clarity from the Fed before extending their own stimulus measures.

While the data from the UK has been mixed at best, the fallout from the Brexit vote earlier in the summer will continue to put pressure on the British pound going forward.

The Dubai Gold & Commodities Exchange pound contract for December delivery is expected to test 128.50 levels, with upsides capped at 132.80 in the weeks ahead.

Similarly, the euro contract on DGCX will range between 109.50 and 113.50.

Gold prices are also likely to remain very volatile through the end of September. Because of its inverse relationship to the dollar, we expect gold to test US$1,300 an ounce, which represents a strong technical entry level for long positions.

Gaurav Kashyap is the head of futures at Axitrader in Dubai.

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