The doctor seems to have prescribed an extreme dose of volatility to the financial markets, with no signs of this easing as we head into Christmas. The pressure we have been noticing in global stocks this week (as a likely reaction to the lower oil prices) is weighing on the USD, with the major currency weakening against the Euro, UK Sterling, Swiss Franc, Japanese Yen, Canadian Loonie, Australian Dollar and Kiwi Dollar yesterday. Some USD weakness was expected this week with the equity markets facing so much pressure, but part of the softness yesterday could also be attributed to nervousness among investors ahead of the conclusion of tonight’s FOMC meeting.
Ahead of the FOMC statement, there is a growing anxiety that the Federal Reserve may display some concern with the free-falling oil markets and perhaps indicate it will postpone raising interest rates. Although we can expect the Federal Reserve to re-emphasize that a potential inflation decline is something that it is watching very closely and fears over low inflation levels would likely have heightened following the PPI decline, we do not expect the Federal Reserve to postpone raising interest rates. There was previously so much unrealistic optimism that the Fed would raise rates as soon as March and now this has passed, but the Fed have indicated it will raise rates between the middle and end of next year and we expect them to follow through with this.
There is a great deal of concern over the global economy, with headlines continuing to resurface and heightening these concerns at least a few times a week. The US economy is very much leading the pack and speculation that the Fed will delay normalising monetary policy would worsen the global economic sentiment tenfold. If the Federal Reserve do take a dovish approach and inspire widespread USD weakness, we are looking at a period of risk appetite in the currency markets.
At the time of writing the EURUSD is erasing some of its gains achieved from yesterday but potential USD weakness would likely make a return to 1.25 later today . Gold managed to climb its way to $1223 on Tuesday, where major resistance can be found at $1238. If the USD did weaken, it would be music to the ears of the Russian Central Bank (RCB) and provide an opportunity for Ruble strength. The Norwegian Krone, Swedish Kronor, Chinese Renminbi and Turkish Lira are other currencies that have weakened over the past week.
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Overall though, we are not expecting the Federal Reserve to awaken the bears this evening. It is understandable that the drop in oil prices are causing economic concerns, and encouraging inflation declines. One way to look at things though, is that disposable income is improving greatly in the run up to Christmas and this should provide a welcome boost to retail sales. Extra disposable income at a time when interest rates are at historic lows also opens the opportunity for consumers to spend money elsewhere, meaning inflation levels should edge its way back north at some point in the future.
The concluding message from the Federal Reserve tonight should be that the US economy is continuing to progress nicely, and more of the same of this is required in the coming months.
*Ahmad is chief market analyst at FXTM.
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