USD: May Fed rate hike looking more likely now – MUFG

The dollar is marginally weaker today in the wake of Francois Bayrou confirming he would not stand in the French presidential election and in response to the FOMC minutes that appeared to reduce the probability of the FOMC hiking rates at the next meeting on 15th March notes Derek Halpenny, European Head of GMR at MUFG.

Key Quotes

“Of course the key question now is what does “fairly soon” mean? – the timeframe “many” FOMC members believe before the next rate increase is warranted.”

“We would argue that “fairly soon” could feasibly mean March, but more probably means May with June too far out for such wording to be appropriate. The March fed funds future contract has barely budged and the implied probability of a March hike remains at about 25% (our calculations). With the next jobs report not until 10th March, a blowout report with a notable jump higher in hourly earnings would probably be required in order for market participants to price in March. We do have both Vice Chair Fischer and Chair Yellen speaking on 3rd March, so an opportunity is there to shape market expectations – but we can’t see at this stage what would incentivise Yellen and Fischer to do that given the jobs report is a week later.”

“But the March Summary of Economic Projections and the press conference could provide an ideal opportunity for Yellen to stress that rate hikes are feasible at meetings when no press conference is scheduled. If the FOMC believes it will become more active in monetary policy and given the increased political uncertainty over the outlook for fiscal policy, the FOMC will likely want to argue the benefits of being able to move at each FOMC meeting going forward.”

“The initial sell-off of the dollar and drop in yields may well reflect the anticipation of a firming of the rhetoric in the minutes in regard to inflation. Given the FOMC statement indicated increased confidence in achieving the inflation target, the minutes weren’t as firm as expected on that front.”

“However, offsetting that and why the dollar sell-off did not have much follow-through and indeed why dollar appreciation may well resume were more hawkish elements like the reference to beginning discussions on the appropriateness of the current size of the Fed’s balance sheet with the implication being that the Fed may stop reinvesting proceeds from maturing holdings and allow the balance sheet to shrink. Secondly, there was also a reference to “several participants” expecting a “more substantial undershoot” of the unemployment rate.”

“Our key message to readers is that the FOMC has managed to keep every meeting live – even March – and while we view March as unlikely, the dollar is likely to remain well underpinned with the minutes continuing to imply that the US yield curve is under-priced for what the FOMC intends to do on monetary policy. While the FOMC formally has a balanced bias to the outlook, a quick read-through of key points in the minutes suggests that the bias is clearly shifting to the upside.”