Dec 15 2017

Predictable Fed, Unpredictable Markets – 14Dec17

As was widely expected, US Fed increased the benchmark interest rates by 25 bps yesterday – third rate hike this year. The Fed kept their inflation outlook for the coming year unchanged but raised their economic growth forecast for 2018. The decisions were mostly on expected lines but currency markets’ reaction was puzzling. The dollar tanked while euro and yen surged.

What could have dragged the dollar lower in an otherwise neutral scenario?

  1. Janet Yellen showed some concerns on inflation, which she felt is more deep-rooted than transitory. This could have prompted the market to short the dollar (presumably doubting the consensus of 3 rate hikes of 2018).
  2. 7-2 vote for the rate move could have been the surprise element – two members dissenting against the rate decision is a revelation – it was the first meeting with more than 1 dissent since November 2016. Three rate hikes for 2018 now gets visibly hazy.

What was the effect on rupee and what next?

Rupee opened with an up-gap at 64.35 and immediately surged to a weekly high of 64.25. During the day, dollar gradually inched back to close at 64.35.

My sense is that rupee has gained quite a bit and could reverse from recent peaks around 64.25-64.30. This could change from Gujarat elections results. BJP win is a foregone conclusion – any number above 115-120 could instil further strength in the rupee. Conversely, if it’s around 95 or below, rupee could weaken.

Technical studies are tilting towards a dollar buy.

Exporters and importers: it makes sense to keep positions adequately hedged before a big event (and a possible big move as well). Importers can use forwards to buy dollars for the short term while exporters should use at-the-money puts.

Traders can buy options to trade volatility.