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FOMC Preview and the Dollar Outlook
The Fed rate hike on Wednesday is fully priced in and the investor will look for clues on balance sheet adjustment and future rate hikes. Currently, there is 50% probability of a Fed rate hike in December and expectations of a balance sheet reduction by next year; in our view this too conservative and we at least expect one full rate hike and a start in the balance sheet reduction this year. That said, the following things need to happen to push USD higher;
- US CPI to improve.
- Median dot plot unchanged or higher.
- Discussion on balance sheet normalisation
- No downward revision in long-term inflation
In terms of forecast, if Fed is hawkish on all four things we are likely to see a USD rally with 112.10 targeted on USDJPY and 98 targeted on USD- index.
Fed is neutral we may see some short-term weakness in USD with 109.00 targeted on USDJPY. Also, there is potential for a further upside for commodity currencies, primarily AUD as the investor will be assured that Fed will not move towards more hawkish surprise. We target .7650 on AUDUSD and 96.50 on USD-index.
A dovish Fed is likely to cause broad USD losses as we are likely to see the building of short-potions which were unwounded to a neutral level ahead of the FOMC. The USD-index is likely to break the key support around the 96.50 and USDJPY to test 108.15.