Prepare for a rate hike – banks post FOMC meeting

The FOMC meeting brought no surprise as interest rates were left unchanged. However, chances of a rate hike as soon as June ripped higher as the market saw the statement as hawkish. What’s more, some banks even think that a move on the next meeting is almost a done deal. Let’s see why and how could it affect the financial market.

Deutsche Bank:

The research team at Deutsche Bank explains that there were no real surprises to come from the FOMC decision to keep rates unchanged or out of the post meeting FOMC statement but there was just about enough for the market to ramp up the odds for another tightening next month.

Bloomberg’s calculator (which overstates a little) now has the probability of a hike at 90% which compares to 67% this time yesterday. With regards to the statement itself the FOMC acknowledged the soft quarter for growth in Q1 and also softness in consumer spending but also emphasised the need to look through it and that the slowdown is likely to be transitory. There was a reference to fundamentals underpinning consumer spending remaining solid and the Committee generally sounded more upbeat on business fixed investment.

On the labour market the Fed said that job gains were solid in recent months. The Committee also acknowledged the drop in core inflation in March and that while market-based measures of inflation compensation remain lower, survey-based measures of longer-term inflation expectations are little changed on balance. So all-in-all more of the same. For now US economists continue to expect the next rate hike to come in June with high conviction for this view.

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 The market is almost certain that the FED will hike in June. On the other hand, a third rate hike this year remains a coin toss. source: Bloomberg

Societe Generale:

Research Analysts at Societe Generale note that the FOMC let rates on hold, as expected, said nothing in the statement about plans to shrink the Fed’s balance sheet (that’ll come later) but did strike a sufficiently upbeat tone in the economic assessment to persuade the rates market to price in a June hike with confidence.

The message seems clear –they plan to look through recent soggy data and expect a bounce. However, for all the market’s confidence in a June hike, pricing of a second one by December has moved very little and the priced-in probability is only 54.4%.

For the dollar, it’s the longer-term rate outlook which matters and that hasn’t moved. 10year yields are up a couple of basis points. 1year rates in 5years’ time are 3bp higher than before the FOMC, but at 2.49% certainly don’t price in a 3% ‘terminal’ Fed Funds rate. The dollar’s been tracking the move sin forward rates closely enough but as the global economy improves and the rate outlook elsewhere changes, the DXY index has been making a series of lower highs and lower lows. The little bounce we are seeing now doesn’t alter that picture at all. 

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 The USDJPY rose after a decision and is close to breaking from the downward channel, which could be seen as a bullish trigger.