Financial markets now expect Fed to hike US interest rates in December
02/Nov/2015 • Currency Updates•
The possibility of a US rate hike in December increased substantially last week after a considerably more hawkish Federal Reserve statement. While rates were left unchanged at the October Federal Open Market Committee meeting, as universally expected, the statement was consistent with our expectations of a labour data-dependent December interest rate hike. According to Bloomberg’s World Interest Rate Probability model, the chance of a hike at the next FOMC meeting is now higher than 50%.
Currency markets reacted by sending the US Dollar sharply higher against all of its major peers. However, the rally was short-lived, and by the end of the week the Dollar was back to roughly unchanged in trade-weighted terms and against the Euro. However, many USD buyers have now looked to fix at least a portion of their exposure to mitigate the possibility of the Dollar strengthening.
Sterling has strengthened significantly, outperforming the US Dollar and all other major currencies last week save for the Canadian Dollar. The Euro is now closer in line with global forecasts and all eyes are now focused on the Bank of England’s Thursday meeting to see whether any other members except McCafferty decide to join the camp for immediate rate hikes.
The Euro came under pressure following news that further quantitative easing may be necessary to push growth in the Eurozone. The new QE measures could be announced as early as December. We’re observing those looking to sell Euros acting before a further stimulus is implemented.
Major currencies in detail:
Sterling strength was somewhat puzzling in view of the lack of strong reports from the UK last week.
Third-quarter GDP was softer than markets had been expecting, up just 2.0% in annualised terms, rather than the 2.5% consensus had penciled in. Construction experienced a sharp decline, manufacturing was slightly negative and services output was up, though slightly less than had been expected.
All eyes now turn to Thursday’s Bank of England meeting and the release of its latest Inflation Report. One key gauge of how close the Bank of England is to raising rates will be whether any other dissenters join Ian McCafferty in voting for an immediate hike. Last week’s soft GDP report probably means that the likelihood is for yet another 8-1 vote.
Also important will be the tone of the Inflation Report and in particular any references to increased downside global risks compared to the August report. At any rate, we expect to have a much clearer read on the timetable for Bank of England hikes after Thursday’s key releases.
While the Eurozone economy continues to face some medium-term uncertainties, these have yet to show up in the economic indicators released so far.
IFO and EC sentiment indices both posted solid increases. The retail sales report points to consumer spending rising close to 3% in the third quarter and core inflation edged higher to 1%, though still far from the ECB’s targets.
These numbers don’t yet reflect the impact of the emerging market slowdown or the Volkswagen crisis, but they paint an encouraging picture of the European economy through October.
Currency traders certainly agreed, and the Euro was able to finish the week essentially unchanged against the Dollar, despite the surprisingly hawkish Fed statement for October.
The Federal Reserve surprised markets with a considerably more hawkish than expected statement.
The Fed explicitly mentioned the possibility of a December hike, which read: “In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress – both realised and expected – toward its objectives of maximum employment and 2% inflation.”
Further, the September comment regarding concern that financial volatility may restrain US economic growth was removed, signalling that the Fed is no longer particularly worried about international financial movements.
Fed hawkishness seems to look past relatively weak GDP numbers, which saw healthy domestic demand (growing at 3% annualised rate) dragged down by a temporary inventory correction, as the headline number printed at just +1.5%.
Interest rate markets are now pricing in a 50% chance of a December hike, up from 30% before the meeting. The contrast between monetary policies across the Atlantic should continue to put moderate downward pressure on the Euro over the medium term.
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