How the Fed’s statement will impact the markets in the months ahead
As expected, the Federal
Reserve increased interest rates for the 11th time to 3.75% from 3.50%.
Following Friday’s jump in consumer inflationary expectations and the sharp rise
in oil / natural gas prices as a result of Rita, the Fed had no choice but to
follow along with their prewritten script for rate hikes. Concerns about
inflation has topped the list over growth, with the dollar soaring as the Fed’s
comments that “appropriate” action will be needed to keep risks for growth and
inflation under control. This outweighed the one dissenting vote to keep
interest rates unchanged.
First off, the FOMC statement does include a new
paragraph on Katrina. In the words of the Fed, “The widespread devastation in
the Gulf region, the associated dislocation of economic activity, and the boost
to energy prices imply that spending, production, and employment will be set
back in the near term. In addition to elevating premiums for some energy
products, the disruption to the production and refining infrastructure may add
to energy price volatility.”
Our interpretation is that this is the Fed’s way
of telling us that expect “near term” data will be bad, as Katrina is expected
to set back spending, production and employment. They are also hinting to the
market that we could see large gyrations in oil prices once again.
Yet looking forward, they do not expect the
impact to be a “more persistent threat.” Of course, if the Fed spelled out a
doomsday scenario of even worse times to come, it would cause a lot of
unnecessary confusion and uncertainty in the markets.
The key to the dollar rally
was the following line:
“The Committee perceives that, with appropriate
monetary policy action, the upside and downside risks to the attainment of both
sustainable growth and price stability should be kept roughly equal.”
The words “with appropriate monetary policy
action” implies that the Fed will continue to be proactive and aggressive and is
a hint that they are still planning on raising interest rates in November. The
word “measured” was also left in the statement.
The only other interesting part of the statement
was the note in the second to last paragraph that said that Olson voted in favor
of keeping interest rates unchanged. The first dissenting vote in a very long
time. If you recall, over in the UK before the MPC lowered rates, we had a few
meetings where the vote was not unanimous and more voters began to sway in a
different direction. Perhaps, Olson’s dissenting vote may be more significant
than we think.
Kathy Lien
Kathy Lien is the Chief Currency Strategist at
Forex Capital Markets. Kathy is responsible for providing research and analysis
for DailyFX, including technical and fundamental research reports, market
commentaries and trading strategies. A seasoned FX analyst and trader, prior to
joining FXCM, Kathy was an Associate at JPMorgan Chase where she worked in Cross
Markets and Foreign Exchange Trading. Kathy has vast experience within the
interbank market using both technical and fundamental analysis to trade FX spot
and options. She also has experience trading a number of products outside of FX,
including interest rate derivatives, bonds, equities, and futures. She has a
Bachelors degree in Finance from New York University. Kathy has written for
Stocks and Commodities, CBS Market Watch, ActiveTrader, Futures and SFO
Magazine. She is frequently quoted on Bloomberg and Reuters and has taught
seminars across the country. She has also hosted trader chats on EliteTrader,
eSignal, and FXStreet, sharing her expertise in both technical and fundamental
analysis.