The Federal Reserve will begin reducing its $4.5 trillion balance sheet, in a very gradual manner. This has been well telegraphed for months and months. Yellen told us that it will be “like watching paint dryâ€. So, no surprises from the main policy decision.
Markets will move on speculation for the next rate hike. Back in December 2016, Yellen and co. upgraded the dot-plot to three hikes in 2017. In the first half of the year, things seemed to go to plan. The Fed raised rates in March and June. Tightening for September will be in the form of reducing the balance sheet and the last move for the year will be another rate hike, for the third December in a row.
But things became more complicated as the year progressed. Wages remained stuck at 2.5% y/y despite healthy job gains. Core inflation slipped to 1.7% and did not rise from there. Fed officials often expressed surprise and disappointment that inflation is not rising. And if inflation is not rising, there is no rush to raise rates.
With fewer chances of fiscal stimulus and worries about the damage from the hurricanes, the odds for a rate hike in December dropped sharply and so did the dollar.
But things changed lately: inflation did not extend its falls beyond 1.7% y/y, hurricane Irma inflicted less damage than predicted and Trump made surprising deals with the Democrats. All this put some color on the dollar’s face and revived the chances of a rate hike.
Scenario 1 – Dollar: first up and then down?
While there is still time until December and the Fed always tells us it is data dependent, markets will not wait before moving.
First and foremost, the Fed publishes the dot-plot alongside the statement at 18:00 GMT. Here, there is a good chance that they will not alter the path of rate hikes for the remainder of the year. This could boost the dollar. Just getting the reaffirmation that the Fed is still set on raising rates could prove positive.
