Hike in June/July, Then Go Away?

Boris Schlossberg

Market Roundup Dow 17,789.67 (+2.47) S&P 2,099.33 (+2.37) NASDAQ 4,952.25 (+4.20) 10-YR Yield 1.85% (+0.01) Gold $1,213.50 (-$2.70) Oil $49.64 (+$0.11)

It’s been exactly two weeks since the release of the Fed minutes, and the change in the currency market is palpable. The greenback is back, having gained on the euro, the yen and the pound since the Federal Reserve signaled that it’s ready to start hiking rates to a surprised market – a market that, in fact, is still pricing in less than a 50% chance of a hike before yearend.
Why did the Fed suddenly get so hawkish?
As Aretha Franklin once said R-E-S-P-E-C-T.
After promising to normalize policy and then backing off so many times over the past 12 months, the Fed was in danger of becoming the Rodney Dangerfield of the financial markets.
Having seen how badly the Bank of Japan butchered its move to negative-rate policy, leading to a strengthening of yen that only exacerbated Japan’s woes, the Fed apparently decided that time has come for action.

Ironically enough, it’s far from clear whether the U.S. economy actually needs a rate hike at this moment. The latest economic numbers show a slowdown in activity, especially in manufacturing.
True, after years of stagnation, wages are finally starting to grow, but the pace is hardly inflationary, with core CPI running at 0.2%. Still the Fed desperately wants to leave QE behind and move toward “normalization.”

The dollar could be set for a surge after a Fed rate hike, but the sluggish U.S. economy could cap the gains.

Here too, the shadow of BOJ looms large. The Japanese central bank has been essentially trapped in the QE quicksand for more than two decades and, the Fed is loath to repeat the same experience.
So Janet Yellen and company have decided to walk a very fine line. They need to achieve “escape velocity” (and if rates go to 75 basis points, that is likely to push them far enough away from the zero-bound level) while keeping the expansion alive as credit gets tighter.
That’s why June or July are the most likely months for a rate hike, after which the Fed can go into hibernation until the end of the year as the chaos of the general election turns the focus to politics rather than economics.

“Janet Yellen and company have decided to walk a very fine line.”

If the Fed makes good on its promise, the dollar is likely to rally further as the summer proceeds, with EUR/USD likely testing the key 1.1000 support, while USD/JPY could bust out above the 112.00 level.
However, given the fact that this move is as much about power as it is about economic policy, the rally in the greenback is likely to be limited as U.S. growth continues to be muted for the time being.
Happy trading,
Boris Schlossberg

Other Developments of the Day

A former director at Barclays PLC was arrested in New York and accused of feeding insider-trading information to his plumber in exchange for a free bathroom remodeling, according to criminal and civil authorities. The 58-year-old was charged in a criminal complaint filed in federal court. He was charged with conspiracy, wire fraud and securities fraud after the plumber, secretly pleaded guilty and agreed to cooperate with authorities. The plumber allegedly made $78,000 illegally.
The former director for the British bank, identified as Steven McClatchey, worked at its Manhattan offices from 2008 to 2015. His lawyer declined to comment.
Japanese Prime Minister Shinzo Abe said he will delay a sales-tax hike scheduled for next year, as the economy continues to show weakness despite three years of his “Abenomics” growth strategies.
Abe said that the country risks sliding back into deflation and must act to avoid a crisis. He said he plans to pass a fiscal-stimulus package in the fall and to speed construction of maglev and bullet-train networks across the country, the Wall Street Journal reports.

Here in the U.S., meanwhile, there are some good economic signs. Consumer spending jumped in April by the largest amount in more than six years, with a big jump in purchases of autos and other durable goods leading the way.

Consumer spending rose 1% last month after a flat reading in March. Incomes rose 0.4%, considered a solid gain and matching the March result. Wages and salaries gained 0.5%. “American shoppers came racing back to the malls, auto shops and online stores in April,” Sal Guatieri, an economist at BMO Capital Markets, told the Associated Press.

What about you? Are you spending more? Two readings on consumer confidence in recent days showed mixed results – one up, one down. How confident are you in the economic future? Are you holding off on anything until after the election? Comment on this or anything else below.

The Money and Markets team