Financial markets are correcting their views on US rate hikes

Enrique Díaz-Álvarez23/May/2016Currency Updates

For some time we’ve been highlighting Federal Reserve communications as the key driver in the currency markets. The gap between market expectations and Federal Open Market Committee projections around the pace of US interest rate hikes had been widening and we didn’t think that the Fed would leave interest rates unchanged for long. The minutes from the April meeting leave no doubt that the FOMC stands by its projections and thinks markets are wrong when they predict just one hike in 2016.

The response to Fed hawkishness was swift. Risk assets sold off and the US Dollar rallied against every major currency except Sterling last week.

As the Brexit is losing ground in the polls, the Pound is making up for its terrible start to the year. Sterling is no longer the worst performing major currency in 2016. That label is now attributed to the Mexican Peso.

June is shaping up to be a very volatile month. The risk events are piling up and, in addition to the EU referendum in the UK, we also have an all-important Fed meeting, the Spanish elections and an ECB meeting coming up.

Unsurprisingly, we are seeing interest from businesses looking to cover their Sterling exposure and some nascent flow of USD sellers who want to avoid the volatility of the June FOMC meeting.

Major currencies in detail:


Data out last week confirmed the absence of inflationary pressure in the UK, despite tightness in the labour market.

Core inflation came out much lower than expected, at 1.2% for the year. The 1% wedge between wage growth and core inflation remains intact, which is a fairly positive outcome as real wages continue to increase modestly.

Retail sales were another bright spot last week and we remain confident that the dissipation of Brexit controversy will bring UK growth back above 2% in the short term.

Sterling continues to be driven almost exclusively by the latest referendum polls. They are increasingly pointing to a win for the ‘in’ campaign and our favorite indicator, the Number Cruncher Probability score, is now recording just an 18% chance of a Brexit.


By contrast to the fireworks generated by the FOMC, the ECB minutes from the April meeting were completely unsurprising.

There is broad agreement in the Governing Council over ECB policy and, beyond that, little was communicated to markets. The Euro followed all other major currencies downward against the US Dollar.

This week we get the all-important business sentiment PMI indices.

The indices have shown very little movement over the past three months. They have remained consistent with modest Eurozone growth in the 1.5-2% range.

If there’s no upward trend in the PMIs this week, the ECB will be disappointed that its monetary easing is not having greater impact.


The FOMC minutes out on Wednesday added to the drumbeat of recent hawkish statements by its voting members.

It would be difficult for the Fed to be more explicit about the mispricing it sees in interest rate markets and it has gone out of its way to communicate that June is definitely a ‘live’ meeting for a second interest rate hike. We think a decent labour report is all it may take to seal the outcome of the June meeting.

Even though market expectations of a June hike have risen to 30% from just 4%, we still think there’s room for this to increase further. The US Dollar clearly agrees with us, rallying against every major currency except Sterling.

There are relatively few major macroeconomic announcements out of the US this week. The relative market calm could offer a good opportunity for businesses to hedge their currency exposure ahead of the large risk events due in June.


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Written by Enrique Díaz-Álvarez

Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.