- The odds of a Fed rate hike next month have receded
- US second quarter GDP could push the chances of a rate hike back to 50/50
- Some see the influence of commodity prices on inflation rate as “transitory”
- Traders will need to tread cautiously this week
By Max McKegg
The US dollar was on the defensive but steady on the major crosses when the New Zealand and Australian markets opened this morning, as events continue to conspire against the consensus the US Federal Reserve
will deliver a rate hike on September 17. Depending on which measure you use, the odds of that happening have receded from 50/50 just 10 days ago to about 30% now. So for US dollar bulls, it’s a continuation of the familiar story: three steps forward and two steps back.
There are some economic data prints due out of the US this week that have the potential to put the dollar back on the front foot, and by this time next week traders may be wondering why they ever doubted its credentials. However a week is a long time in the markets and there is a lot of water to go under the bridge, so traders will need to tread cautiously.
The falling price of oil has played havoc with central bank inflation targets, but some respected figures believe the impact of the crude oil plunge will only be transitory. Photo: iStock
Inflation expectations slump
First let’s look at a chart that summarises concerns as to why the rate hike, and therefore the dollar rally, has been postponed, if not cancelled. Inflation expectations – a key indicator for monetary policy – began the year in a promising uptrend with the break-even inflation rate derived from the spread between conventional Treasury bonds and the same maturity Treasury Inflation Protected Securities (TIPS) heading towards 2%. But in the last few weeks the trend has reversed and is heading back towards the previous lows, dragged down by crude oil
Source: ANZ Bank. Create your own charts with SaxoTrader; click here to learn more.
The Federal Open Market Committee
(FOMC), along with its “Big Three” central bank colleagues in the European Central Bank
and Bank of Japan, have pencilled in an oil price of about $70/barrel by mid-2016 as a basis for projections their common 2% inflation target will be reached. That wasn’t a stab in the dark; rather reliance on the futures curve applying at the time. Oil can be a volatile beast, so the price could still reach that level in time to save the day, but hard-nosed traders are doubting it. Hence the falling break-even inflation rate in the chart above.
Nevertheless, there are plenty of respected observers who think the influence of commodity prices on the inflation rate will be “transitory”. One of those is Federal Reserve board heavy-weight James Ballard. In an interview discussing monetary policy on Friday he said the outlook for economic growth was “relatively good”, there had been “very good progress” in the labour market and “I think you can look through the decline in oil.”
His confidence that the oil price won’t become a spanner in the works will be tested on Friday when we get an update on the Fed’s inflation benchmark, the price index of Personal Consumption Expenditures (PCE). Ballard must know as well as everyone else that the July headline rate won’t have risen much above zero and that it would be wishful thinking to expect the year-on-year rate of increase in core PCE to have “rallied” any further than 1.4%.
But those taking the “glass half-full” approach to the US economic situation are likely to get more joy from Wednesday’s second quarter GDP update. Ballard expects the economy to expand “above trend” in the second half of 2015, and a good number this time will add credence to that view.
The first estimate of the annual change in the second quarter was 2.3%, as shown in the chart below. Wednesday’s update could take it up to a very solid 3.2% or even higher, and all of a sudden the odds of a September rate hike would be back up to 50/50 and the dollar back on the menu.
Source: New York Federal Reserve
The case against delay
When it comes to taking a position on the will-they-or-won’t-they question of a September rate hike, it’s worth keeping in mind that it won’t be “the market” that makes the call but just the 10 voting members of the FOMC, and although he is a highly respected member of the Federal Reserve Board, James Ballard doesn’t have a vote this year. So while his comments on Friday were interesting, we will get more pertinent guide to the outcome when on September 4 Committee voter Jeffrey Lacker outlines the arguments for an imminent rate hike in a speech entitled “The case against further delay”.
The date and title of the speech were released on Friday, and Lacker would have been well up with the play on economic developments post the FOMC’s last meeting on July 28-29. So we can assume the title was carefully chosen and therefore chalk him up as a “vote in favour” when a rate hike is discussed at the September meeting. Presumably then, Ballard, Lacker and fellow bulls on the FOMC are loading up on inflation-linked bonds for their personal accounts. Another influential Committee member William Dudley will be speaking this Wednesday.
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– Edited by Robert RyanFor more on forex, click here.
Max McKegg is managing director of Technical Research Limited. Follow Max here or post your comment below to engage with Saxo Bank's social trading platform.