Markets dramatically reprice potential June Fed rate hike

Markets are playing catch up to communications from the US Federal Reserve as they appear to have dramatically under-priced the likelihood of a rate rise over the coming months.

Federal Reserve
Source: Bloomberg

The release of the Fed minutes for their 26-27 April meeting has seen a dramatic rally in the US dollar as most policymakers believed a rate rise in June would be “appropriate” if the data holds up. This saw the market pricing for future rate hikes shoot up with the probability for a rate hike in September now sitting at 62.7% and for July at 49.6%. The DXY dollar index rallied 0.7% to close above a key resistance level of $95.1. Commodities and commodity currencies fell sharply, with the Aussie dollar plummeting 1.2%.

What is clear from the minutes and recent speeches from Fed speakers is that the Fed is very keen to try and get two rate hikes out this year. And if that is the case, then there will be a strong push to try to raise rates in June or July. This is set to make all US economic data releases even more volatile than usual as markets try to incrementally price the likelihood of rate hikes off each additional data point. The Atlanta Fed’s GDPNow estimate for 2Q is sitting at 2.5%, and GDP at 2% or above may in fact be enough for the Fed to hike. Given all this, the current 49.6% market probability pricing for July seems dramatically low.

The ASX is set to open relatively flat, although the sharp rally in the US dollar may make for a difficult day in the materials and energy space. Conversely, ASX-listed exporters and foreign currency earners may expect to rally sharply on expectations for a potential June or July rate rise by the Fed.

The Nikkei looks set for a very strong day as the USD/JPY exchange rate moved back into the 110 handle. After better than expected GDP and now another 0.8% weakening of the yen, it is likely to be smiles all around for Japanese exporters.

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