The US dollar's recovery that began yesterday continues today. The euro reached the 50% retracement objective of its slide since mid-October (~$1.2565) and now is more than a full cent lower. The dollar's slump against the yen ended just above the JPY115.50 level, also a key technical retracement level. The dollar's high today was JPY117.50.
This is not say the dollar's recent decline was purely technical, but that–squaring of positions not a change in fundamental views–seemed like the main driver. The dollar's slide began after new highs were recorded on December 8. Since then the implied yield of the December 2015 Eurodollar futures fell by more than 20 bp. The implied yield on the December 2015 Fed funds futures contract fell 18 bp. We think this reflects ideas the disinflation impulse from the first and secondary impact of the drop in energy prices will limit Fed's hikes next year.
The FOMC meeting today is the main focus. The US November CPI figures to be released earlier are of little consequence, though for the record the headline is likely to ease (from 1.7% to 1.4% with downside risks, while the core is sticky (unchanged at 1.8%. Within the FOMC statement the key interest is in how the Fed modifies the statement relating to interest rates remaining low for a considerable time after the asset purchases are complete. The asset purchases are over. The statement will change. Some expect the entire phrase to be eliminated.
We suspect that it will be replaced with something focusing the market's attention on economic data. We expect that the recent retail sales, including auto sales and the industrial output figures following the strong employment data will spur the Fed to upgrade its economic assessment.
How the statement characterizes inflation and the downside risks posed by the decline in energy prices will also come under scrutiny. As Fischer and Dudley have already hinted, we expect the FOMC to look past the short-term impact and focus on the stimulus side. It is not simply that consumers spend shift spending from gasoline to something else, but rather that something else is likely, based on consumption patterns, to have a greater multiplier effect for the domestic economy.
