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Hawkish shift in Fed policy, eyes on ECB

December 16,2021 10:36:49

Overnight Headlines

*Fed signals three 2022 hikes in inflation pivot, doubles taper

*Asian markets open cautiously after US stocks swing higher

*Dollar rises after Fed statement, pulls back on press conference

USD jumped on the initial headlines from the FOMC. It rose to highs of 96.90 before closing around 96.51. EUR/USD fell to 1.1221 and then reversed, though closed below 1.13. USD/JPY reached 114.27 and currently trades above 114. Bumper jobs data in Australia pushed the aussie back up into resistance around 0.7170. USD/CAD spiked to a high of 1.2937 but pulled back and remains in a strong resistance zone.

US equities reversed earlier narrow losses seen before the Fed. Stocks then rallied with the S&P500 closing at its second highest close on record. The tech-heavy Nasdaq jumped 2.3% and the Dow advanced 1.1% as defensives like utilities and healthcare lagged. Asian markets are mixed with US futures mildly in the green.

Market Thoughts – Fed goes early

So, it was in the end all about the updated dot plot. The Fed now expects to raise rates three times in 2022, having previously been evenly split on the prospects of a lift-off in rates next year. Most in the market forecast them to perhaps be a touch more cautious due to the Omicron uncertainty. It doubled the speed of tapering as expected.

The Fed continue to project three additional hikes in 2023 but now predict only two more rate hikes in 2024 versus the three they forecast in September. The net result is there is now one extra hike through to 2024 compared to the previous dot plots, but they start sooner. The terminal rate remains the same.

The immediate market moves look like the adjustment of positioning and sentiment. The market was long dollars and short stocks into the decision, so these positions look to have been covered. The Fed won’t let inflation spiral out of hand. The dollar should eventually begin a new upleg versus the low yielding euro and yen.

Chart of the Day – EUR/USD still pointing to lower prices

Today’s ECB meeting should after all is said and done reveal the contrast between two central banks. The Fed has revealed its hand. The ECB may not increase rates until late 2023 or early 2024, with today’s revised inflation forecasts showing no reversal towards target further out.

Markets are pricing in 10bps of hikes by the end of next year and another 20bps by end-2023. This appears to be too aggressive so EUR/USD should move lower in time. Near term, yesterday’s low forms an initial support level around 1.1221/27. The figure and then 1.1186 will offer more substantial support. Resistance is 1.1289 and around 1.1350.

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