Federal Reserve’s Jerome Powell seen cautious, $A may rally

US Federal Reserve chairman Jerome Powell is expected to reaffirm his cautious approach to monetary policy this week, potentially paving the way for an extended rally in the Australian dollar.

The Aussie has battled back from below US71¢ less than two weeks ago and is now within reach of US73¢, helped by a muted market response to the latest trade tariff moves by the US and China and the return of a semblance of calm to emerging markets.

The local currency has had a tough year. This week’s Fed gathering and whether the message from Mr Powell and his colleagues is deemed US dollar dovish or hawkish, could help to determine whether the Aussie can hold onto recent strength.

The Fed’s open-market committee will conclude a two-day meeting on Thursday AEST with a policy statement – a 25 basis point rate hike is expected – and updated economic projections, including for the first time forecasts for 2021.

Mr Powell will host a news conference on Thursday AEST where he'll be pressed on the pace of future rate increases.
Mr Powell will host a news conference on Thursday AEST where he’ll be pressed on the pace of future rate increases.

Charles Rex Arbogast

Mr Powell also will host a news conference where he’ll be pressed on the pace of future rate increases amid an emerging debate about the timing of the next slowdown.

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Rising US rates have boosted the greenback this year as has stellar economic data. The Atlanta Fed’s GDP forecast model has the US economy expanding at a 4.4 per cent annual pace in the current quarter.

The Fed statement and Mr Powell’s comments will be parsed for any signs of wariness about the expansion’s momentum.

Any hesitation about the US economy’s outlook, could lead to more repositioning by US dollar bulls. Bets that the greenback would appreciate were the third most crowded trade this month, according to Bank of America Merrill Lynch’s September global fund manager survey.

The reality is that the Fed is set to lift rates further – traders have firmed December bets in futures markets – and so the US dollar is set to retain its rate advantage against most other currencies well into 2019.

“With the economic party raging, the Federal Reserve is widely expected to drain some more punch from the bowl,” TD economist Leslie Preston said, adding the central bank appears far from done: “We expect the Fed to hike four more times over the next year, placing the fed funds target at a peak level of 3.25 per cent in 2019.”

The challenge for investors, as it is for Fed policymakers, is more nuanced.

“We suspect the FOMC will signal in its statement the need for policy, moving forward, to potentially become more nimble when it comes to rate hikes compared to the current workmanlike (quarterly) pace,” Bank of Montreal deputy chief economist Michael Gregory. “This could mean longer-than-one-meeting pauses or none at all (the latter becomes easier with the advent of pressers after each meeting next year).

“In any event, we suspect the phrase: ‘The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labour market conditions, and inflation near the Committee’s symmetric 2 per cent objective over the medium term’, might be modified.

The ‘for now’ qualifier that chairman Powell experimented with recently could be included, or the ‘further gradual’ reference could be dropped and replaced with a more ambiguous ‘additional’.”

The dot plot – or the specific rate forecasts by individual policymakers – is expected to be little changed for both 2019 and 2020.

“With two US rates hikes priced into [the balance of] 2018 and in the absence of inflation, it’s almost impossible for the Fed to bump up the 2019 curve,” OANDA’s Stephen Innes said in a weekend note.

“So, the markets will end up focusing on shifts in the long ball forecast into 2020 which is not the best or brightest of signals for currency traders who tend to view markets in much nearer time horizons,” Mr Innes said.

Even if the Fed prods its 2020 forecast curve higher, it’s unclear how much of a US dollar fillip that shift could deliver given that Mr Powell has continued to de-emphasise 2020 dots.

The addition of projections for 2021 in this week’s update however will help firm policymaker’s forecasts for growth, employment and inflation for 2019 and 2020.

PIMCO economist Tiffany Wilding said in a recent blog post that the Fed is nearing the point in its current rate-raising cycle where the direction of monetary policy becomes more uncertain: “the Fed’s medium-term policy dilemma of how to balance the risks of over-tightening with the risks of over-heating”.

If Mr Powell hints that the rate rising cycle is nearing an end point, TD anticipates a renewed US dollar sell-off. That could help the Aussie further pare its year-to-date losses against the greenback.

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