In what is setting up to be the Historic event of the year, the US Federal Reserve prepares for its very first rate hike in over 9 years. With most of the economic data done with, the stage is set for the Fed to hike interest rates by 25bps in an effort to bring the US monetary policy back to normalization.
The Fed funds futures rates, according to the CME Group is pricing in a 79.4% probability for the interest rates to be hiked by 25bps.
With most of this year being dominated by the Fed’s interest rate hike, the markets have adequately priced in the rate hike and thus leaving not much room for the US Dollar to rally into the event. This signals that in the short term, most of the currencies are likely to spike higher, especially the Euro, considering that the Single currency has the highest weightage in the US Dollar Index.
Besides the currency markets, the equity markets will also be looking to scale back their long positions and as evidenced last week on Wednesday and Friday, the sudden volatile sell-off in the equity markets has given rise to a strong risk aversion as investors scale back or trim their risky holdings. Understandably, the Swiss Franc and the Yen, in particular, have strengthened significantly. It is very likely that we will see at least another instance of a sell off before Wednesday’s FOMC event.
US Fed Rate hikes – Looking beyond
With the rate hike now as good as done, the markets will be looking to what to anticipate next. Obviously, the pace of rate hikes will be on everyone’s mind. Currently, there are mixed views, with some economists on the hawkish side expecting to see four 25bps rate hikes in 2016, which could bring the US benchmark interest rates to around 1.50%. On the dovish scale, some economists expect to see at least two 25bps rate hikes, preferably in March 2016 and July 2016, which could bring the US benchmark interest rates to 1.0%
Thus, the markets will be looking to a 1.0% – 1.50% US interest rates by the end of 2016.
For the moment, however, Wednesday’s FOMC decision is likely to see the Fed take a dovish stance in a bid to soothe the markets by noting that the pace of rate hikes will be gradual and that the Fed will remain accommodative.
The emerging markets have been particularly hit since October’s Fed statement which put the December rate hikes on the table. For example, the Dollar has strengthened by nearly 14.64% against the Ruble, while rising 3.46% against the Indian Rupee and 3.63% against the Chinese Yuan.
The Dollar’s strong performance combined with a rate hike cycle has evoked concerns that it could potentially signal the start of a new global recession as the emerging markets struggle with capital inflows and also having to service their the previously US denominated debt against higher interest rates and with global trade flows already showing signs of a slowdown alongside the slump in commodities including precious and base metals as well as Crude Oil, it is highly likely that going forward, the Fed would do as much as it can to ease the concerns.
US Federal Reserve Meeting Details
- When is the Fed meeting? December 16th, 19:00 GMT
- Expected Fed Funds Rate: 0.50%
- Previous/Current Fed Funds Rate: 0.25%
- FOMC Economic Projections (Includes Fed staff projections on inflation & GDP, aka dot plot)
- FOMC Press conference due at 19:30 GMT