The Fed decision is coming soon, and markets remain tense. While there are at least 4 scenarios, the initial reaction will come down to the question of the rates: to hike or not to hike?
The team at Citi suggests two different trades with two different currency pairs:
Here is their view, courtesy of eFXnews:
The September FOMC meeting remains a very close call with the Fed hiking remains the base case for Citi.
“Citi’s baseline is for a 25bps hike, but there remains considerable scope for surprise, as well as hifting communication to play a role. Ultimately we think the decision boils down to how the FOMC sees market conditions, and whether the recent volatility could lead the FOMC to temporarily postpone hiking,” Citi projects.
“In our view we place a 25% chance of a hike, and 75% for no hike. Still, the risk/reward favors a more hawkish outcome. We think the next most likely possibility would be for the committee to signal the October meeting as live, a hawkish outcome for the bond market,” Citi adds.
Impact on markets:
1- If September hike – Buy USD/CAD
“Initial reaction is clearly USD positive through the rates channel. Distance on USD rally depends on how market extrapolates the tightening path (after SEP/Yellen signals). We like USDCAD higher under a Fed hike, signaling a more hawkish reaction function, supporting the yield differential and dampening the external demand impulse to Canada. To the extent that EM faces renewed pressure, oil prices could also act as a drag on CAD,” Citi advises.
2- If September skipped – Buy AUD/JPY.
“If September is skipped, the reaction in FX is going to depend on the motivation. If it was market volatility, EM uncertainty and the USD, then October is more likely to be in play. Instead, if its inflation and a view the NAIRU is considerably lower, 2015 could be off the table. Both scenarios indicate more dovish reaction functions, should support risk, steepen the yield curve and boost JPY crosses,” Citi adds.
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