Preview: Fed’s December Rate Decision

After dominating the headlines for much of the year, trade war concerns eased after Presidents of China and the US finally agreed to a self-imposed 90-day truce to work out a plan to end their dispute. Progress was already on the way, judging by optimistic tweets from Donald Trump and after media reports suggested that China was moving towards lowering its 40% tariff on US-made cars. Prior to the leaders’ meeting at the G20 summit, Trump had again used aggressive tough-talk tactics, threatening to impose tariffs on $267 billion of Chinese imports if they don’t make a deal. His unorthodox negotiation tactics have been rather controversial to say the least. But proponents would argue that he has managed to successfully renegotiate trade deals with its neighbours Mexico and Canada, while he has also made some North Korean friends. The fact that he’s applied the same approach to China isn’t a surprise – and it is arguably working again. But after boasting so much about the stock market gains, he will be desperate to forge a deal now that the major US indices have turned red on the year. So, if a trade deal were to be reached early next year, our assumption is that import duties will be lowered again, which should push down import costs and therefore dampen inflation. The Fed will be aware of this possibility and may mention it in its rate statement or press conference. If so, the markets may price in the prospects of reduced urgency from the Fed to hike rates in Q1, and potentially lead to a rally in stocks and a drop in yields and the dollar.

Regardless of the outcome of the US-China trade deal, the US dollar and bond yields may start easing back anyway. The recent turmoil in emerging market currencies has undeniably hurt demand. This has been highlighted, for example, by falling sales of the iPhone and a drop in German exports causing their economy to shrink in Q3.

Other economic pointers in Europe have been far from impressive, raising doubts that the European Central Bank would be in a rush to raise interest rates next summer – especially in light of the recent plunge in oil prices. I

n the US, too, we’ve seen some softer-than-expected macro pointers lately, triggering a couple of Federal Reserve officials to talk cautiously about the prospects of further economic expansion. At the same time, the Fed’s hiking cycle has been heavily criticised by Donald Trump himself. Indeed, the US President has gone as far as to say that the “the Fed right now is a much bigger problem than China.”

Taking everything into account, the Fed is still one of the most hawkish central banks out there and this is reflected in the dollar rallying. But with the pressure growing from Trump and given the recent fundamental developments, the central bank may well change its hawkish tone, potentially leading to a dollar sell-off. While it may very well be less aggressive in raising interest rates next year, the ongoing strength of the US economy means the Fed will tighten its belt at this upcoming meeting.

Regardless of the current fundamental developments, the higher highs and higher lows means the technical trend still looks bullish for the Dollar Index. But past performance is not necessarily indicative of future results. The upcoming Fed decision or some other fundamental stimulus may well cause the DXY to break down from its long-term bullish channel or form some distinct reversal pattern at higher levels. If seen, only then will we turn decisively bearish on the dollar.