Comment: Markets price pause after Fed's June hike

Digital Look WebFG News | 14 Jun, 2017 11:59 - Updated: 12:59 | | |


Analyst Ipek Ozkardeskaya discusses the major drivers for the Fed policy, expectations for 2017 and examining the positive and negative risks on the US dollar.

The Federal Reserve's June monetary policy meeting began on Tuesday and the Federal Open Market Committee will announce its decision and indications about future policy late on Wednesday.

The FOMC is widely expected to raise the Fed funds rate by 25 basis points at this week’s meeting.

After keeping the US monetary policy loose for more than a decade, the Fed will therefore have raised rates for the third time since December, a month after Donald Trump’s election as President of the United States.

However, the June meeting could mark the end of the Fed’s knee-jerk reaction to the Trump presidency, with rate hike expectations beyond this week’s policy meeting waning.

Major drivers for the Fed policy

Trump’s election has been a major trigger for the Fed’s rate normalisation policy. The reflation rally in the stock and commodity markets, combined to speculations of massive government spending and fiscal reforms under the Trump rule, translated into higher inflation expectations in the US.

Hence, the Fed was somewhat brought to rapidly adjust its monetary policy in accordance with the new policy environment.

The Fed raised its interest rates by 50 basis points as a knee-jerk reaction to the unprecedented rally in the US and the global equity and commodity markets, also known as the ‘Trumpflation’ rally, and is expected to continue with an additional 25 basis points rise in June.

In the aftermath of the period from November to June, the June rate hike is certainly not necessary, however, the markets have mostly priced in the latter Fed action. Therefore, a non-action from the Fed would needlessly trigger a panic in the global markets and fire back on the Fed.

Beyond the June meeting, the Fed expectations are waning.

Fed could take a breather as Trump-euphoria is temporarily intercepted

It seems like the Trumpflation rally is running out of steam. First, Donald Trump failed to bring his massive spending plans and the fiscal reforms to life in his first six months in office.

The lack of details on his colossal spending and fiscal plans has gradually tempered the enthusiasm in the US stocks and encouraged some investors to return to the US bonds. The US 10-year yields eased below the 2.20% after rising above the 2.60% on the post-Trump euphoria.

Rising tensions between the FBI and President Trump has been the last nail in the coffin, as the escalating crisis obliged Trump to deal with an issue to defend his seat as President and unpreventably delayed his fiscal agenda.

Under the current circumstances and following 75 basis points rate hike, the Fed would have gone one step further in June and could comfortably pause until the end of 2017.

The next rate hike is expected in December, the earliest. Depending on the fiscal leg of the US policy, the Fed could even skip another rate hike in 2017 and concentrate its efforts on balance sheet normalisation plans.

Negative and positive risks for the US dollar

The US dollar index (DXY) gained 6.42% in the aftermath of the Trumpflation rally and returned to the levels before the US election by the beginning of June.

Currently the dollar index is below its 100-week moving average (97.67) and could extend losses toward 95.00/93.00, the lower range of 2015-2016, before regaining the 100.00 level.

The USD outlook for the second half of the year is therefore skewed negatively.

If the Fed decides to take a pause on its rate normalisation policy as expected, the major upside risk to the US dollar would be its portfolio normalisation plans.

Although the speculation on the Fed’s balance sheet shrinkage plans could temporarily boost the US dollar and the yields, the Fed is set to shrink its 4.46 billion dollar worth balance sheet gradually and the latter could have less than a 25 basis points hike in rates.

Ipek Ozkardeskaya is a senior market analyst at London Capital Group

More news

17 Dec Sunday newspaper round-up: Poundland, Lloyds, Brexit, broadband, Amazon

The scandal-hit parent company of high street discount chain Poundland will this week face key creditors and insurers at a meeting that could determine the future of its British retail operations. Poundland is already under intense pressure after Atradius - one of the credit insurers on which suppliers rely to ensure they get paid - reduced its cover for the group. Reliable industry sources say another credit insurer, Euler Hermes, is also considering cutting cover. - The Sunday Times

15 Dec London close: Footsie gains as pound drops, Wall Street hits fresh highs

The top flight index recovered some ground on Friday, but mostly on account of weakness in Sterling after German Chancellor Angela Merkel reportedly echoed other European Union officials, saying "the most difficult phase is ahead of us".

15 Dec Week ahead: US data, Catalan elections in focus

The focus in the coming week will continue to be on the ebb and flow of data out of the US, including Republicans' progress on securing passage of their tax cuts.

15 Dec US open: Stocks jump as Republicans move to secure passage of tax cuts

Wall Street is heading higher again on Friday amid news that Republicans were tweaking their proposed tax cuts in order to secure prompt passage of the US tax bill.

15 Dec Airbus chief executive to step down in board shake-up

The chief executive of French planemaker Airbus will step down from his position in 2019 as the company announced a major shake-up of its management team.

15 Dec FTSE 250 movers: TalkTalk rises but Serco gives back gains

London’s FTSE 250 was up 0.1% to 20,023.23 in afternoon trade on Friday as the Christmas lull kicked in.

15 Dec US industrial production rises slightly less than expected in November

Industrial production in the States rose slightly less quickly than expected last month, despite higher output of business equipment and materials.

15 Dec Strategic Minerals renegotiates acquisition of Leigh Creek Copper Mine

Diversified mineral production and development company Strategic Minerals announced on Friday that, after the successful completion of technical and financial due diligence on the Leigh Creek Copper Mine company, it has agreed to continue with the acquisition on renegotiated terms.

15 Dec FTSE 100 movers: Sky jumps but retailers retreat on H&M sales

London’s FTSE 100 was up 0.3% to 7,469.23 in quiet afternoon trade on Friday.

15 Dec Gfinity partners with Microsoft for next Halo World Championship

International esports entertainment group Gfinity has been named as a preferred event partner to Microsoft for the forthcoming ‘Halo World Championship 2018’ for the next season, it announced on Friday.