- Market reaction to Yellen's speech on Friday seem overblown
- However, one rate hike seems to be on the cards this year
- As usual, Yellen says that it depends on upcoming data
- This week sees updates on the Fed’s key inflation and labour market indicators
By Max McKegg
An hour and a half after Federal Reserve Chair Janet Yellen’s speech on Friday, her deputy Stanley Fischer was on CNBC interpreting her comments as being consistent with the possibility of a rate hike at the Sept 20-21 meeting of the Federal Open Market Committee.
It was Fischer’s words that sent a thrill of excitement down the spines of FX traders, and by the close of New York trading we had chart reversal days on all G10 USD crosses
. This was quite a reaction given all Yellen actually said was that “in the light of the continued solid performance of the labour market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months”.
As usual she went on to say that the proof would be in the pudding: the now standard “data dependence” line. We will all get a taste of the pudding this week as updates on the Fed’s key inflation and labour market indicators are on the data menu.
When it comes to rate hikes for the US, the proof will be in the data pudding. Photo: iStock
First up is today’s price index for Personal Consumption Expenditures. As the following chart shows, momentum has dropped off in the last couple of months and economists are not expecting there was much change in July either. So we’re still waiting for the effects of previous energy price declines to “dissipate”, to quote Yellen’s preferred terminology.
In the meantime, the headline index – the Fed’s benchmark – remains under 1%; not even half-way to the target level. Hardly an environment in which to be raising rates one would have thought.
The second big data point is Friday’s jobs report, and no doubt there will be plenty of previews posted here on Trading Floor ahead of that event.
As the week begins, the odds for a rate hike by the FOMC’s December meeting are now between 60% to 70%, depending on whether the point of reference is the Overnight Index Swap market or the federal funds futures quoted on the CME. Either way, the calculation is quite complicated, so for a quick reference tool I use my own chart of the fed funds shown below (Click to enlarge).
Fed funds have been trading around 0.40% for some time now, close to middle of the FOMC’s 0.25% – 0.50% target range. So if a rate hike of 25 basis points were to be delivered, the December fed funds contract would close out at a yield of 0.65%, or a price of 99.35 (represented by the bottom line on the chart).
Alternatively, if the FOMC sits on its hands and leaves rates where they are, the contract will close out at a yield of 0.40%, or a price of 99.60 (the top line). As you can see, by the close of trading on Friday, the price had slipped well under the 50/50 line, suggesting rate-hike odds of about 65%.
Janet Yellen wasn’t the only central banker dropping hints about monetary policy at Jackson Hole. Both Bank of Japan Governor Haruhiko Kuroda and European Central Bank Board member Benoit Coeure said further policy easing was on the cards unless governments step up to the plate with substantial fiscal stimulus.
At first sight the market reaction to Yellen’s speech and Stanley Fischer’s interpretation of her remarks seems overblown: reversal days on all the major USD crosses. The evidence does suggest the Fed’s policymaking committee is lining up behind the idea of at least one rate hike this year, at the same time as other central banks are maintaining an easing bias.
But talking the talk it one thing: This week’s key inflation and labour market updates will show us when – or if – the FOMC will walk the walk. In the meantime, FX traders have got the bit between their teeth and seem determined to front run the Fed.
– Edited by Gayle Bryant
Max McKegg is managing director of Technical Research Limited. If you would like an email notice each time Max posts a trade or article then click here or post your comment below to engage with Saxo Bank's social trading platform.