Hawkish FOMC minutes prompt sharp market reactions

May 19, 2016

The minutes from last month’s FOMC meeting were released on Wednesday afternoon. Overall, the release was significantly more hawkish than many had expected, notably stressing that a June interest rate hike would be likely if economic growth data continues to progress as expected. As always, improvements in the labor market and inflation were noted as key precursors to a potential rate hike.

During April’s meeting, concerns were brought up about sluggish US economic growth as well as a potential UK exit from the European Union, but these risks were counterbalanced by improving US employment conditions and expectations that inflation would reach the Fed’s target.

Prior to the release of the minutes, the Fed Fund futures market was pricing-in around a 19% probability of a June hike, already higher than the sub-10% probability that prevailed within the past few days and weeks. After the release, however, the probability quickly jumped as high as 34%, and continued to climb.

As expected, the immediate market reaction was a sharp surge for the US dollar, which had been trading moderately higher prior to the release. Another major reaction was an equally sharp plunge for US stocks, which had been rising strongly prior to the release. Also taking a significant hit, as might have been expected from a hawkish Fed release, were both gold and crude oil prices.

This hawkish stance emerging from April’s FOMC minutes has also recently been supported by a series of positive economic data, including better-than-expected numbers for Retail Sales last week as well as for Tuesday’s Consumer Price Index (inflation measure), Industrial Production, and Housing Starts. With any continued positive data as has been seen of late, the probability of a June rate hike should continue to increase in the run-up to the next FOMC meeting, especially in light of the Fed’s apparently increasing hawkishness. This could potentially lead to significantly further gains for the dollar and possibly a sharp pullback in the price of gold.

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