The most uncertain part of tomorrow's US rate decision is not what the Fed will do but how markets will react

Getty / Scott Olson

While Asian stocks are ripping higher today, buoyed by another bout of short covering following days of relentless selling, the same can’t be said for currencies markets. They’re as flat as a tack.

This is hardly a surprising outcome, particularly given the proximity of tomorrow morning’s crucial US FOMC policy decision, an event that is likely to herald the first interest rate increase in the US since June 2006.

“If ever there was going to be a day of twiddling thumbs ahead of key event risk, surely today is the day,” said Ray Attrill, global co-head of FX at the NAB in his morning note, perfectly summing up the price action seen so far today.

While that may be the case now, it’s unlikely to remain that way come 6am AEDT Thursday when the US rate decision is delivered.

The question on what the decision, economic forecasts and Fed chair Janet Yellen’s press conference will do to currency markets is, in all honestly, the most uncertain part of the entire event.

Whatever you call it: Priced in. A near-certainty. Baked in the cake, almost everyone is expecting a rate hike.

So too are expectations that future rate hikes from the Fed – should they arrive – will be slow, small and steady.

FOMC members have been priming markets for that to occur for months, and it’s likely to be reflected in the Fed funds rate forecast path – simply known as the “dots” – in which individual FOMC members offer their own expectations on where interest rates will sit in the future.

A rate hike and slower schedule for interest rate increases are now deemed to be almost a given. The only thing with any degree of uncertainty is how the currency markets will react.

With markets expecting a “dovish” rate hike and trader positioning long, it suggests that there is a significant risk that the US dollar will initially decline: a “buy the rumour, sell the fact” scenario to borrow market lingo.

However, such a response is already expected by many market participants, creating an even greater amount of uncertainty.

It’s easy to see why currencies are doing nothing today – traders worldwide are pondering. If you’re sitting next to one now, you can probably hear their mind ticking out loud.

While no one can be sure of the answer – including Fed members themselves – if there’s one thing that’s guaranteed, it’ll be significant volatility.

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