Potential reassessment of Fed rate hikes by the market
While market implied probability still indicates no Fed hike before 2017, but there could be some anxiety and volatility ahead of the 14-15 June FOMC meeting. Some Fed officials recently called for two rate hikes this year, including one in June or July.
Meanwhile, economic newsflow is now more likely to surprise on the upside after the sharp downward revisions to 2016 GDP growth forecasts seen over the past year (the consensus has moved from 2.8% a year ago to 1.8% currently).
Furthermore, inflation has bottomed out – core CPI is now above 2% – and the base effect from the rebound in oil prices will push it up further in coming quarters. In this context, the market could move towards our scenario (our Fed watcher expects one 25bp hike in December this year).
Expect more volatility rather than market commotion:
We are talking about a 25bp hike after all: the Fed will remain significantly behind the curve, as it has been for the last few quarters. First of all observe IV nutshell for dollar crosses in OTC FX markets, for every change in pip of USD crosses IVs responding massively.
This is clearly part of the explanation behind the recent US dollar weakness – decreasing Fed expectations and the economic surprise indicator heading south since April – as US real rates took the driver's seat.
We believe that a slightly more hawkish repricing by the markets would be likely to result in greater volatility rather than market disruption. As argued by our US rates strategist, the market has a rather complacent view of a moderate repricing of hike expectations:
With the 10Y bond yield trading close to the bottom of the 1.702-1.890% range over the past few weekly, there is a risk of a significant pick-up in volatility. Furthermore, we don't think the Fed would want to be back at centre stage as a trigger for risk-on/risk-off moves.
The material has been provided by InstaForex Company – www.instaforex.com