Fed-Fueled Rollercoaster Continues

May 23, 2016

In the midst of the G7 meetings of finance ministers and central bankers beginning in Japan, this week in foreign exchange was largely focused on the anticipation of, and then reaction to, the Federal Reserve’s latest public communications. The minutes from last month’s FOMC meeting were released in the middle of the week, and the results represented yet another dizzying turn in what has become a Fed-fueled rollercoaster ride for the financial markets.

Although many Fed-watchers had already been anticipating a slightly more hawkish upturn from the FOMC this time around after months of apparently dovish-leaning statements, the central bank went a step further. The most salient aspect of April’s FOMC minutes was the fact that members deemed a June interest rate hike to be likely if Q2 economic data continued to improve as expected. This was among the strongest assertions in recent months from the Fed in support of a potentially imminent rate hike, and the financial markets immediately grasped onto its implications.

The US dollar swiftly strengthened while gold fell sharply from near its recent highs. Jittery stock markets, most notably in the US, experienced heightened volatility, at first plunging but then regaining stability and rebounding towards the end of the week.

In a Thursday press conference, New York Fed President William Dudley, who has traditionally been more of a dove, appeared to support the hawkishness of the FOMC minutes, asserting that a June or July rate hike would be reasonable.

The Fed Fund futures markets, which had been pricing-in sub-10% probabilities of a June rate hike in recent weeks, jumped up to ~20% shortly prior to the release of the FOMC minutes. Immediately after the release, the probability surged to a high of around 34% and has remained heightened not far from this level as of Friday.

In the aftermath of the release, while equity markets have subsequently appeared to shrug off the increased likelihood of a near-term rate hike, the US dollar and gold continue to be affected in expected ways. As of Friday morning, the dollar has remained well-supported and gold has continued to be pressured off its recent highs. With the latest series of rather positive economic data out of the US to further support the Fed’s hawkish turn, these trends could very likely continue in the run-up to the next FOMC meeting in June.

Next week is a relatively light week in terms of economic data releases from the US, with the notable exception of GDP data to be released next Friday. This will be the Preliminary GDP (second release) and should have a substantial impact on the Fed’s consideration of current US economic growth.

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