A detailed response to the Fed: watch for more dollar weakness - Westpac

Analysts at Westpac offered their response to the Fed.

Key Quotes:

"The Fed followed through on their strong signal lifting Fed Funds for a third time this cycle, +25bp to 0.75-1.00%. Markets were looking for hawkish guidance and wary the Fed could signal a more aggressive pace but neither the projections, the median dots or the statement suggest that is the case.

The dot plot medians are largely unchanged with 3 hikes still seen this year and next, though the 2019 median was bumped +0.125% while the neutral rate was left unchanged at 3%. That said, there is a hawkish migration among the “dovish dotters” with fewer participants below the median across the forecast period. For example, there are now 3 dots below the 2017 and 2018 median for 3 hikes, down from 6 and 7 respectively as of the last projections.

Growth, inflation and labour market projections saw only very minor revisions. The longer-run unemployment rate was trimmed 0.1ppt to 4.7% but there was no corresponding increase in the Fed’s long run PCE inflation projection or the long run median Fed Funds rate, arguably a dovish development.

The statement is not obviously more hawkish overall: risks are still seen “roughly balanced”, the outlook is for “moderate growth” and the interest rate guidance calls for gradualism, all bedrock comments the Fed has stuck with for some time. Squint and you will find a couple hawkish additions, for example the Fed appears more confident on inflation noting it is, “…moving close to the Committee’s 2% longer-run objective” vs “is still below”. The Fed also says the outlook will, “warrant gradual increases” vs “warrant only gradual increases”.

The USD has fallen across the board (-0.6% to -0.8% vs EUR, JPY, AUD and NZD) as market pricing for Fed hikes has eased.

There is a clear post-dot plot momentum effect in both rates and FX markets suggesting yet more USD weakness in coming sessions. We observe a strong positive correlation between the USD one week after the FOMC and the direction and magnitude of the change in the Fed’s dots from meeting to meeting. The same applies to interest rates.

As the slide below shows JPY and CHF appear to be the most responsive to the FOMC dots in the week following the FOMC but the impact wears off 10 and 20 days later. By contrast  AUD, NZD, CAD and the ADXY appear to be fractionally less responsive one week after the FOMC but the impact tends to “linger”. 

The absence of any overt hawkish guidance from the Fed and their dots should leave the USD trading on the back foot over the next month, history suggesting that JPY is likely to absorb most of the strain initially but the more lasting effect will be felt by the likes of AUD, NZD, CAD and the Asian currencies."