Morgan Stanley's US economics team on how to trade into the Federal Reserve meeting today
Barring a shock, the FOMC will lift the federal funds rate for the first time in nearly a decade on Wednesday, says Morgan Stanley.
Trading The Fed:
"Our US economics team expects the FOMC to emphasise a message of gradualism in the statement and press conference, as well as a shift down in the dot plot to show a median expectation of three hikes for 2016. Of course, the FOMC will aim to avoid an unnecessary tightening of financial conditions via reactions in FX, equities and credit. But we'd argue that the 'dovish hike' scenario is already well priced, with the pace of tightening next year (MSP0KE Index) implying 2.5 hikes," MS argues.
"We think risks are skewed to a less dovish outcome, as there is no guarantee the dots will come down and the Fed's data-dependent approach may dominate the message of gradualism.
Thus we like the risk/reward of being long USD into the meeting," MS advises.
The two-tiered USD:
"Of course, it matters what you go long USD against. We think the combination of weak commodities, stress in high yield and uncertainty about China's FX policy may lead funding currencies to outperform.
The deterioration in risk sentiment is supporting our bullish JPY call, and EUR's negative correlation to risky assets is strong, especially given the disappointing ECB announcement earlier this month.
Should the Fed's messaging fail or broader macro concerns weigh on risky assets, USD is actually vulnerable against EUR, JPY and other non-commodity G10 currencies.
Therefore we prefer to play USD longs against AUD and CAD in G10 and select EM currencies such as TRY and BRL," MS adds.
Enjoy ...