FOMC Has Finally Lifted US Rates, Cities Robust Economy

On December 16, 2015, the FOMC raised its interest rate by 25bps, as was largely predicted, but with dovish sentiments.

The Federal Open Market Committee (FOMC) delivered its first rate hike in almost a decade.

In its opening remarks, the FOMC noted the ongoing US economic recovery,

“Household spending and business fixed investment have been increasing at solid rates in recent months, and the housing sector has improved further; however, net exports have been soft.

“A range of recent labour market indicators, including ongoing job gains and declining unemployment, shows further improvement and confirms that underutilization of labour resources has diminished appreciably since early this year.

“Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports.” 

In her post press conference, Chair Janet Yellen reiterated this sentiment saying,

“With the economy performing well and expected to continue to do so, the committee judges that a modest increase in the federal funds rate is appropriate. The economic recovery has clearly come a long way.”

Dovish Sentiment Prevailed

However, the FOMC statement was sure to note that the December rate liftoff was the first small step of a gradual tightening process.

The FOMC duly noted that its inflation target of 2% was not reached and cited the factors for this, such as low oil prices. 

Hence, the FOMC has placed a renewed importance on its inflation target for the next rate hike cycle stating in its press release,

“In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.”

And although the board voted unanimously, the vote was a compromise between the hawks and doves; for the doves, they were promised gradual rate increases once economic targets and conditions are met.

Sealing this agreement, Chair Yellen stated at the press conference, “The [rate hike] process is likely to proceed gradually.”

USD To Weaken Broadly Against the G10

HSBC Global Research has predicted that a dovish rate hike would lead to a weaker USD against its G10 currency rivals.

Though this US rate hike scenario was the most likely, it was not fully priced in by the markets, but the general expectation should result in a limited reaction in G10 currencies.

Looking back at history, the HSBC team notes the USD has weakened in all the last four tightening cycles, and this dovish one should be no different especially as it came after some disappointments in recent US economic data.

HSBC Global Research observes,

“[In 2016], it means any future soft data will not just raise questions over the pace of hikes, but will raise the possibility of a pause or even reversal.

“USD weakness is likely to be evident against the EUR and JPY over time given both face constraints on additional monetary easing, largely because their central banks are running out of bonds to buy.

“The ECB faces the additional constraint of internal resistance to aggressive easing, judging by December’s meeting’s underwhelming outcome.

“GBP may also rally as markets look for the next central bank to follow the Fed. Expectations that the BoE might wait a year or more before acting strike us as stretched.

“AUD and NZD are likely to see some support also in a ‘risk on’ environment that today’s outcome should foster. After all, when the FOMC minutes that signalled a dovish December hike were released, the markets reacted with relief.

“However, we would not chase the commodity currencies too much higher as they are likely to face verbal intervention from their central banks, especially as commodity prices remain at such low levels historically. Plus there is plenty for ‘risk on’ currencies to worry about apart from the Fed.”