USD Analysis 9th of December

With the USD having appreciated consistently for approximately eighteen months, there is massive long positioning in the market. Many traders will be looking to book profits at some point and the first rate increase maybe a prime opportunity to do so, in a classic “buy the rumour – sell the fact” style of trading behaviour. Accordingly, we advise against being long USD after the rate hike, and although the fundamental long-term bullish bias will remain intact, we speculate that selling USD on post rate hike profit-taking may be a worthwhile trade, depending of course on all the relevant factors at the time, such as the tone of the FOMC Statement.

USD Summary

• Core PCE for October, released November 25, showed y/y inflation remaining at 1.3% for the third consecutive month, and inflation for the month dropping to zero. This was the first zero rise in Core PCE m/m since January.

• Annualised Preliminary (2nd estimate) GDP for Q3, released November 24, printed at 2.1%, revised up from 1.5% in the Advance reading.

• FOMC Minutes relating to the October 27-28 meeting, released November 18, contained no major surprises but showed that most policymakers anticipated US economic conditions and outlook could well warrant a December rate hike.

• CPI for October, released November 17, came in close to expectations with headline inflation for the month rising 0.2%, as expected, and also 0.2% since 12 months prior, which was slightly above 0.1% expected. Core CPI was in line with expectations rising 0.2% for the month and 1.9% for the annual period. The failure of CPI to move lower suggests that the Fed have a green light to raise rates in December.

• Employment for November, released December 4, showed solid payroll growth once again at 211K, however wages aren’t building any steam at 0.2%. The unemployment rate held steady and low at 5.0%.

USD Analysis

At of the start of December, the market is pricing a close to 78% chance of a 25 basis point increase to the Fed Funds Rate on December 16. The Fed have clearly communicated their intention to raise rates soon, with employment being strong and the overall economy expanding, however inflation remains subdued, which could provide arguments for the doves.

The Fed kept the Federal Funds Rate on hold at the October 28 meeting as was expected, citing lack of job growth and below target inflation. The market was pricing only a 6% probability of liftoff at this meeting. The accompanying statement was relatively hawkish and signalled for a December liftoff. The greenback rallied after the release of the statement, with probabilities of a December liftoff rising. The hawkish statement’s most notable change was the introduction of the sentence, “In determining whether it will be appropriate to raise the target range at its next meeting”. This explicit reference to December was telling and clearly shows that the Fed wants the market to expect liftoff on December 16.

The FOMC Minutes for the October 27-28 meeting, released on November 18, did not contain any major surprises but did show that most policymakers anticipated US economic conditions and outlook could well warrant December rate hike. The minutes clearly left the door open for a move in December, but dependent upon data. The USD reaction was relatively muted with the dollar failing to extend on its recent rally, as the market was likely hoping for a more hawkish surprise. CME FedWatch Fed Fund futures implied probability for December decreased from 72% to 68%. A rate hike in December remains highly likely.

After two months of disappointing readings, the employment situation in the US showed strength for October and November. The latest print on December 4 showed solid payroll growth once again in November at 211,000, with an upward revision to an already strong October, raising it to an impressive 298,000. Wage growth is not as impressive, however it did meet market expectations for the month at 0.2%, the y/y ticked down to 2.3% from 2.5%. The unemployment rate is steady and low at 5.0% and the participation rate even nudged higher to 62.5% from the previous 62.4%. While without some weaknesses, overall this report will support the Fed’s plan to begin monetary policy normalization in December.

The Fed have clearly stated that they need to be confident that underlying inflation is moving back towards the 2% inflation target before raising rates. Core CPI rose 1.9% during the 12 months ending October 31, unchanged from September, while Core PCE remained at 1.3% for the third consecutive month for October. For the month of October Core PCE was zero, which is the first flat reading since January. This is one argument against the Fed raising rates in December. However, given that y/y readings for both Core CPI and Core PCE are not moving lower, the Fed may be satisfied to make the first rate hike. We remain bullish on the USD in the long term.

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