Last week, the minutes of April’s Federal Reserve meeting revealed that several officials believe they could move forward with a possible June or July rate hike. This surprised the market a bit, as many had thought that the Fed would do only one rate hike this year, in December.
The futures market shifted from a 14 percent probability of a June rate hike to a 40 percent probability. And as expected, the dollar gained strength accordingly.
The Fed’s official view still calls for two more rate hikes this year and the market is trying to adjust to this reality.
Certainly, domestic reasons justify raising rates today. Recent U.S. retail sales back up strong consumer spending for second quarter, the core consumer price index is around the desired 2 percent level and the unemployment rate is still at one of its lowest points in years.
But let’s look at today’s global economic environment: There is still a huge savings glut in the advanced nations and an ongoing deflationary threat.
That means there are still some check points the Fed needs to clear on a global, macro level in order to move rates up:
- The “Brexit” scenario dissipates and turns into a “Bremain” – meaning that Britain will vote to stay in the European Union. Over the past week, opinion polls are showing that this is likely and as a result, the British pound is rising quickly – even outperforming the dollar.
- Global stock markets remain stable even taking into account this possible early U.S. rate hike. Recent stock market sentiment has recovered even with stronger commodity prices, possibly suggesting that economies have become strong enough to withstand adverse events.
- Emerging market economies are stable. With the exception of the Mexican peso, the other emerging market currencies seem to have bottomed in January of this year.
- The Chinese yuan remains stable. The People’s Bank of China, the Chinese central bank, has already set the Chinese yuan at its lowest level in five years in anticipation of a possible U.S. rate hike and a stronger dollar. Chinese officials are looking more for stability at this point.
My View: If all the above four conditions are met, a Fed rate hike may happen sooner than December. Whether it occurs in June or July will probably not matter that much but, more importantly, it could happen this summer rather than in the winter, in which case the dollar will start to gradually strengthen further.
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