What a shift we’ve seen in US interest rate expectations over the past two days.
From a little less than a 50% chance just a little over 24 hours ago, the probability of a rate hike from the US Federal Reserve on March 15 is now seen as very likely, rather than a possibility.
According to Fed Fund futures, markets are now pricing in the probability of a 25 basis point hike at around 80%, a significant move in such a short period of time, and well above the 20% chance that was seen at the start of February.
It’s now on like Donkey Kong, to borrow a popular slang phrase.
Like financial markets, Richard Grace, the Commonwealth Bank’s chief currency strategist, has now seen enough, joining an increasing number of analysts in calling for a rate hike from the Fed in two weeks.
Grace says there’s three factors that have seen him bring forward the timing of a hike, something that he previously saw occurring in June this year: recent US economic data, a distinctly hawkish shift in commentary from Fed policymakers and a conducive global backdrop at present.
Here’s Grace on recent strength in US economic data and financial markets:
The US economic data continues to surprise to the upside, and the US economy has picked up momentum. US January headline inflation, at 2.5% is somewhat uncomfortable for the Fed, and risks lifting inflation expectation. The US core CPI, at 2.3%, has been at or above 2.0% for 15 consecutive months. President Trump’s pro-growth policies are likely to keep US economic momentum high. The US stockmarkets, at record highs reflect the growth optimism.
And on the shift in sentiment from Fed policymakers recent days:
Yesterday’s hawkish comments by New York Fed President William Dudley that “the case for tightening has become a lot more compelling” has given us confidence that the FOMC heavyweights are convinced the time is right for another lift in the Fed funds rate. Fed Chair Janet Yellen speaks later this week (4.30am Sydney time Saturday) and is likely to confirm the case for a lift in rates. The Fed do not want to be accused of “getting behind the curve”.
And finally, the macroeconomic environment globally at present:
The global economic environment is currently in a relatively comfortable state. The three major economic blocs (US, Europe and China) are currently showing of major sign of economic stress. The unemployment rates in all the major economies are coming down. Market measures of volatility and risk — including the VIX, credit spreads and stockmarket direction — are all at a point where a lift in the Fed funds rate would not be de-stabilising, nor are major risk or surprise for participants.
Combined, Grace says the FOMC is “likely to take this opportunity to lift rates,” citing a lull in concerns about upcoming European elections and few signs of an obvious financial crisis occurring in financial markets.
While Grace is not alone in his view, he’s got form on the board recently with his market calls, predicting a rally in US stocks and dollar on the back of a Donald Trump victory months before the US election took place.
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