Will the Fed’s dovish tone continue?

Tonight we have the all-important October FOMC rate decision and statement and although it seems as though a rate rise looks very unlikely, there could still be high levels of volatility at this event tonight at 6pm UK time. It is the penultimate policy meeting of the year and although October has been taken out of the running for the Fed’s first rate hike, December is still in play and tonight’s meeting now becomes an important indicator of the Fed’s intentions in December.

Below we have outlined the two possible scenarios for tonight’s outcome in relevance to the FX market.

Scenario 1

Hawkish - The Fed signal a rate rise is likely in December.

Firstly, it will be pretty obvious that Dollar strength will occur if this is the outcome. The Fed Funds Futures at the moment are pricing in a first rate hike of 25 basis points as late as June 2016 so there will be a lot of scope for markets to catch up on. This will result in a sell off against the Dollar, with the Euro and Australian Dollar currencies leading the way due to their central bank easing bias and therefore will see the worst of the selling pressure. The Pound, although will decline against the Dollar should still be relatively well supported as the UK’s economic performance is similar to that of the US and markets will see the chance of a BoE rate rise increase once the Fed hike.

Scenario 2

Dovish - The Fed remain dovish and signal a rate rise looks unlikely in December.

Dollar selling will no doubt occur. There is likely to be less fluctuation if the Fed was to indicate a 2016 rate rise as markets at the moment have priced a Fed rate hike as far as June 2016. Conversely, the Pound will likely suffer on the crosses despite gaining ground on the Dollar, as a rate delay will increase the chances of a delay in the UK rate rise race. In this case the Euro and commodity-linked currencies should be the biggest winners as these are the biggest short positions against the US Dollar and the most likely to be squeezed higher on US Dollar weakness. This theory occurred after the Fed disappointed market’s in September.