Is the US Federal Reserve about to hike interest rates?
There’s been a dramatic shift in expectations over a rate hike from the Fed this June, which has naturally powered a recovery in the USD, and should a tightening of monetary policy really occur, it could go quite a bit higher.
Not that long ago there was only a 4% expectation of a rate rise in June, but given the noises coming out of the Fed that has risen to 30% and nearly 50% for July. Indeed, those expectations have stopped the USD index (a basket of currencies versus USD) collapsing through a major consolidation pattern.
One of the main reasons for not pushing rates up in June would be to see the results of the UK referendum on June 23 over its membership of the EU. Though it looks highly likely to remain in the Union – a vote to leave would come as a shock to world financial markets.
The Fed’s next FOMC meeting is on June 14-15 and the one after that is on July 26-27.
It’s difficult to argue that the US badly needs an interest rate rise – the economy is hardly firing on all cylinders. Also, the idea that unemployment will trigger inflation if it falls below 5% - roughly where it is now – is theoretical. Wind the clock back several decades the threshold was thought to be 2.5%. At the moment pay rises are running at 2.5%, not yet in danger territory, but not deflationary either.
But there are two reasons why the Fed might act.
The first is reputational. The Fed wants to be as good as its word and to be seen to be ahead of the cycle.
The second reason is inflation itself. The stabilisation in energy prices has started to feed through into the inflation numbers. Core inflation, which is the number the Fed really focusses on, is at 2.1% versus the overall inflation target of 2%.
In other words, raw material costs and pay rises are potentially lifting US inflation back towards its target and the Fed wants to make sure it doesn’t stray very far beyond that.
Though there’s clearly been a desire to lift interest rates for some time – the reason for hesitating is constant wrenching uncertainty over the global economy. Also, the US economy may be more fragile than it appears with corporate profits under pressure, for example.
Also, a rate rise could unsettle global markets creating extreme volatility and uncertainty, which would further dent global growth prospects and those of the US – where GDP growth expectations of around 2.5% are already fairly modest by historical standards.
The market’s focus will now shift increasingly towards energy prices, economic data and speeches by various Fed members over the coming weeks. Thursday sees US core durable goods orders and weekly unemployment numbers and Friday preliminary GDP, which will be very closely scrutinised. The following week – Friday June 3 – sees Non-Farm Payrolls and as long as the number isn’t particularly bad ie above 100,000, a rate rise could still be on.
The Fed is certainly preparing the markets for a rate rise, which is leaving USD crosses primed for some big bouts of volatility whether it follows through or not.
TECHNICAL ANALYSIS: EUR/USD – Trend in doubt
With the prospect of a US rate hike looming large, the EUR/USD rally looks increasingly in danger. In fact, the pair look very close to breaking down. US economic data over the coming weeks is likely to be particularly influential and will certainly trump the technicals as it will be seen as pivotal to any Fed decisions on monetary policy.
Indeed, EUR/USD is now ultimately waiting for the Fed to dictate direction.
Though some important support levels have been cleared away, in the shorter term the pair could be due a short-term rally or a short consolidation from sometime this week. The pair have bounced off the lower Bollinger band and the daily slow stocks could be close to issuing a strong buy signal, if that happens that could suggest a recovery. However, the daily RSI is above oversold territory and is roughly neutral.
Short-term support can be found around 1.1167, 1.1143, 1.1098. Resistance can be seen at 1.1311, 1.1378 and 1.1532.
By Justin Pugsley, Markets Analyst, MahiFX