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Everything has Changed

Since Trump was elected President last month, markets quickly moved to fully price in a further rate increase from the US Fed at this week’s meetings, largely based on the notion that further fiscal stimulus is on the way. As such, the main focus of Wednesday’s meeting will be the accompanying statement, but more importantly the Fed’s projections for the coming year and beyond. Almost without fail, the Fed has previously been over-optimistic on the extent of future tightening. This time last year, they were anticipating nearly four increases in the Fed Funds rate through the course of 2016. In reality, we look set to get only the one delivered this week. Of course, at this juncture, we don’t know whether this time is going to be different. But what is different is that investment banks and pundits are now more in agreement with what markets are pricing, if not running ahead of it. This contrasts with last year when markets were at most pricing two rate increases for 2016 and most of the time less than that.

So what does this mean for the dollar? It’s going to be down to whether the Fed endorse the market thinking, which is for two further increases in interest rates through 2017, or their projections see more than that. Remember, these are the projections of individual committee members, not a ‘forecast’ of where the Fed thinks interest rates will be in the future. But it probably matters more than was the case 12 months ago, because overall the collective thinking that we are on the cusp of a series of rate increases is now far stronger. After last week’s down-move on the euro, the dollar is not that far from new highs on the dollar index and a more hawkish Fed could easily see those new highs created. We have UK jobs data and US retail sales before then to keep us company. Sterling was initially stronger after firmer inflation data yesterday, but that strength struggled to be sustained, ending the day weaker against both the dollar and single currency.

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