FOMC preview: will Chinese developments shift Fed outlook?

Rate-hike expectations outweigh rate cut

Wednesday 29 January brings the first Federal Open Market Committee (FOMC) meeting of 2020, with Federal Reserve (Fed) chair Jerome Powell weighing up an environment where fears over a US-China trade spat shifts to the virus currently hurting economic projections.

US President Donald Trump utilised his time in Davos to both talk up his achievements and simultaneously criticise the Fed for holding back that economic growth. For all his calls for negative interest rates, economic outperformance and negative rates typically do not go hand in hand.

With that in mind, market expectations currently price in a 0% chance of a rate cut, while some (10%) are actually looking for a potential rate hike on Wednesday. The recent rise in rate-hike expectations will be a reflection of the recent US-China trade deal, with that phase one deal allaying much of the fear surrounding the potential for further tariffs between the two nations.

Will Chinese fears impact the outlook?

This forthcoming meeting has few reasons to expect anything to different, with a lack of economic forecasts and high confidence of a rate hold meaning that it will be unlikely to cause major volatility. However, the one major event that has taken shape over the past fortnight has been the coronavirus crisis in China, with the country struggling to get to grips with the outbreak. This can have significant implications for markets and economic forecasts, as is being seen throughout global markets. From an economic perspective, the longer this plays out, the more detrimental it will be for the global economic outlook.

With many looking towards the thawing US-China relations as a reason to believe we will see the economic picture recover, they are now faced with yet another reason to believe we could see further economic strife going forward. It is also worth noting that a weakened China will be less able to adhere to the purchasing targets laid out in the phase one trade deal with the US. With that in mind, traders will be keen to understand where the Fed stands on the topic. Will their outlook be shaped more by the coronavirus outbreak, or the phase one trade deal (which could be undermined by the former)?

Dollar breaks higher from channel support

The dollar basket has been on the rise over the course of the past month, with the index rising through the crucial 97.37 resistance level. That points towards a potential recovery coming into play following a decline into the bottom of a one standard deviation channel. With the price having now created a higher high, it looks likely we will see further upside for the medium term. Perhaps we will see a dovish shift as the Fed takes on a proactive approach in the face of a possible Chinese economic shock. However, with markets pricing in zero chance of a rate cut, there is a feeling that a dovish tone is highly unlikely. With that in mind, further upside does look likely before long, with a break below 95.95 required to break out from this long-term uptrend.