The Federal Reserve and a December Rate Hike

There is a quiet week of economic data coming up for the US Dollar. Which will be good for the almighty buck and which not so good? There are simplistic explanations for those who trade the world’s most liquid currency which can lead to some misconceptions and shock traders going forward. This interest rate advantage the Dollar has can easily become cumbersome. In the event of heavy event risk, the safe-haven identity could flip. The Dollar is becoming a currency that is more and more complicated to trade and highly susceptible volatility in the financial system.

There are beacons of light that will cause volatility coming up. The upcoming FOMC rate decision, this Wednesday will garner the interest of traders. The Federal Reserve is the only central bank, of the major players, hiking interest rates right now. The Fed’s actions, inactions and words carry a lot of influence. The Fed has done a lot to try and acclimatize trader expectations across the financial spectrum to an imminent rate hike. The Fed is on a very slow path to monetary policy normalization and is very interested in financial stability. One rate hike is tolerable, two would cause even more angst in an already anxious atmosphere. There is also a very contentious US Presidential election less than one week away. A move now, could tip the scales on risk aversion, mentioned above.

Should the Fed decide to hike rates this week, we could see an extreme reaction. The US Dollar rally could come to an end as we see a lack of overall demand in the general capital markets. We could see economic uncertainty rearing its ugly head. The US Dollar has seen support from expectations in a rate that is further out. Not a small 25 basis points from last year and another weak 25 basis points at the end of this year. A pullback in the financial markets along with a reduction in economic growth would scuttle the path of normalization as well as the Dollar’s hold on its yield premium. We could see it, eventually, gain again as a safe haven but there would be a lot of ground to recover.

This Friday, the non-farm payroll and the PCE deflator, the Fed’s preferred gauge of inflation, will cross the wires. These are effective event risk for the Dollar, especially on the back of a rate decision. A lot of the US Dollar’s recent moves, over the past several weeks, has been thanks to the weakening of its counterparts. This could change this week.