The Fed dropped a bomb this past Wednesday when it released the latest FOMC minutes—a rate hike in June is possible. Weak US growth in the first quarter of the year and a slowdown now, coupled with nonfarm growth below 200K jobs might have suggested a more tamed statement. Markets responded to the surprise with a selloff in Treasuries and equities and a surge in the Dollar. And yet, despite the explicit mention of June, a rate hike in September seems more likely.
Just like the December 2015 rate hike, the Fed softens the blow by throwing out the possibility of a rate hike before the conditions are actually ripe for one. By the time the Fed actually lifts rates, the money market and the bond markets have adjusted and the shock is minimal.
It’s easy to cling to June because the FOMC literally mentioned it as an option, but further examination of the statement that followed made it crystal clear. The FOMC minutes clearly stated, “Data has to be consistent with a pickup in growth in the second quarter, a firm labor market and the FOMC inflation target of 2%, to warrant a rate hike.” Yet, it’s hard to see data underpin a pickup in growth before GDP growth for Q2 is released. Retail Sales growth, recovery in credit and an uptick in PMI readings can suggest that growth in Q2 will recover, but only an actual GDP number will confirm it. It is an unnecessary risk for the Fed to raise rates prematurely considering the weak readings of Q1. A rate hike in September however, could prove much more convenient. By then, GDP growth for Q2 will be known and indicators could suggest whether Q3 growth also appears solid. Having two quarters of solid growth would be much more amenable to a Fed rate hike and under such circumstances would be better digested by markets.
June Hike vs. September Hike
How a rate hike by the Fed will play out in the FX arena will depend on the timing. A June rate hike, while less likely, could still occur. But a rate hike coming so soon after a rather choppy second quarter for equities and before data is concrete, is likely to trigger a selloff in equities and a flight to safety. This is likely to hit emerging market pairs such as the Brazilian Real, the Russian Ruble, and even the Mexican Peso, as well as the Euro, the Pound and the Aussie. Of course, the two safe havens, the US Dollar and the Japanese Yen would benefit. And that means that a rebound on the USD/JPY could be derailed in the short run as the Yen gains ground alongside the Dollar.
A rate hike in September is an entirely different story. The Dollar will likely recover broadly against most currencies, including the Yen, but a flight for safety is less likely to be triggered. Riskier currencies, such as the Mexican Peso, the Brazilian Real and even the Aussie could still perform well against weaker peers such as the Euro and the Yen.
Nevertheless, it’s important not to lose sight of the two pillars. Nonfarm payrolls and consumer credit will have to deliver for the Fed to move rates higher and for the Dollar rally to turn wider.
Look for my post next week.
INO.com Contributor - Forex
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.