Dollar could rally sharply on hawkish FOMC

The Federal Reserve’s latest policy decision this evening is the main macro event for today and quite possibly for the week, unless the Bank of Japan comes up with something better tomorrow (unlikely). We, like most other analysts, expect interest rates to be held unchanged, but the focus will be on two other key issues. First, how the FOMC will present the outlook for interest rate changes going forward, as will be indicated on the so called dot plots. Second, their plan, if any, on normalising the Fed’s enormous balance sheet.

In making their decisions, policymakers at the Fed are likely to take into account last month’s sharper-than-expected rise in CPI inflation, and weigh this against somewhat softer macro pointers elsewhere in the economy. But with employment remaining healthy and inflation being so close to its target, the Fed may get the market ready for another rate rise in December and also provide a plan for balance sheet normalisation. In other words, the Fed may be more hawkish than dovish at this meeting.

If so, we would expect the dollar to rip, especially against currencies where the central bank is still very dovish – for example, the Japanese yen and the Swiss franc. This outcome may also be modestly negative for the US stock markets. If the dollar rises and stocks fall, then gold’s response may be relatively muted, although as a dollar-denominated commodity it too should fall. Obviously if the Fed comes across as more dovish than hawkish then one would expect the opposite reaction in these markets.

USD/CHF one to watch

But my base case is that the dollar may rally as a result of a more hawkish Fed than expected. With the Swiss franc softening across the board in recent times, the USD/CHF could be in for a sizeable move higher in this potential scenario. The Swissy has already shown signs that it doesn’t want to fall further lower, as indicated for example by the sellers’ unsuccessful attempts to push it below the 2016 low of 0.4445 throughout the summer. They have had three futile attempts in as many months to crack this level. This clearly suggests that the buyers (or the SNB) are probably coming back in. I say “probably” because so far we haven’t seen a sharp enough rally to suggest the sellers are done. But that could change as early as today with a hawkish FOMC statement. Any move north of 0.9650 resistance would be bullish in the short-term, with the next potential objectives being at 0.9705, 0.9770 and 0.9850/65 – the latter marking the convergence of the 200-day moving average with a prior broken support level that hasn’t yet been retested.

Meanwhile the key short-term support levels to watch include 0.9590, 0.9505 and then that 0.9445 level. A decisive break below 0.9445 would completely invalidate the bullish scenario outlined above.