Fed Headlines Busy Central Bank Roster

This past week launched December’s lineup of major central bank decisions with relatively uneventful statements by the Reserve Bank of Australia (RBA) and Bank of Canada (BoC), both of which kept interest rates unchanged. The RBA left its cash rate at the record low 1.50%, after having cut by 25 basis points back in July. The BoC also kept steady, leaving its overnight rate at 0.50% as it has remained for nearly a year and a half. Both central banks cited global economic growth as a key factor in their decisions to refrain from cutting interest rates further. These expected policy outcomes were naturally not very market-moving, but they were followed on Thursday by the European Central Bank (ECB), which provided significantly more currency volatility.

The ECB provided a couple of surprises for the markets that ultimately resulted in a sharp plunge for the euro, especially against the Fed-driven US dollar. Overall, the ECB decision and statement were mixed, but leaned significantly more to the dovish side. First, the central bank’s quantitative easing program consisting of extensive bond purchases was extended for a longer-than-expected nine months – to December of 2017. Second, a firm date for “tapering” (though not labeled as tapering) of those bond purchases from 80 billion euros/month down to 60 billion euros was set for April of 2017. In the end, the prospect of prolonged quantitative easing to the end of 2017 and potentially beyond weighed heavily on the euro. EUR/USD’s initial spike above 1.0800 was rapidly reversed, pushing the currency pair back down towards the key 1.0500 support level once again.

Continuing the roster of major central banks next week, the Fed will take center stage on Wednesday. Much has already been said about the prospects for this highly-anticipated event, as expectations for a 25-basis-point rate hike have continued to run extremely high. The Fed Fund futures market currently sees the likelihood at around 97%. Indeed, these expectations for a December rate hike have been so consistently high that they may very well have already been priced-in to the sharply surging US dollar. Therefore, a more critical variable to watch for in next week’s FOMC announcement is how the Fed may frame the future of interest rate increases, given the recently higher expectations of rising inflation that could potentially be driven by the new Trump Administration. Any hints of increased monetary policy tightening for next year could boost the dollar even more, while any continued focus on the often mentioned “gradual pace” of tightening could cap dollar gains.

After next Wednesday’s Fed decision, two other central bank decisions will round out the week – the Swiss National Bank (SNB) and the Bank of England (BoE), both on Thursday. Finally, early the following week features the Bank of Japan’s policy statement. The SNB is expected to keep its negative Libor target rate unchanged at -0.75%, which has been at the same level for nearly two years. The BoE is also expected to keep its official bank rate steady at 0.25% after having cut by 25 basis points in August on post-Brexit concerns.

With the busy calendar of central bank decisions next week, currencies will be in sharp focus, particularly the US dollar and British pound. A key currency pair to watch will be EUR/USD in the aftermath of the ECB decision and ahead of the Fed decision. As noted, EUR/USD has dropped sharply in the past two days to re-approach major support around the 1.0500 level. Any strong breakdown below 1.0500 next week could trigger a significantly more severe slide eventually towards parity.