Has the Fed bought ‘optionality’ on the September meeting? If buying ‘optionality’ involves raising the market expectations of a rate rise to the point where the Fed can if desired raise rates without significantly surprising the market then at least based off fed fund futures, so far this has been a failure.
Can the Fed pull-off a relatively benign “dovish” rate hike in September?
Yes: i) The back-end of US yield curve will be well behaved which should be helpful for EM and equities; ii) USD/CNY and oil will create less instability; iii) the Fed can credibly tell a story of ‘hawkish in the short term, but dovish in the longer term’.
No: The market is unlikely to conclude this is a ‘two hikes and done’ rate cycle, and 2017 fed fund futures will surely sell-off significantly.
In the end a rate hike that is so far from being priced in is bound to make some dent on risk/FX carry in the run-up to a tightening. The extent to which the market thinks that the Fed could follow with another hike in December, will have a significant impact on how FX and global asset markets absorb any September hike.
The long-term FOMC dots coming down will ameliorate some, but not all of the risk impact. Reigniting the strong USD M/T view does not need anything like a normal Fed rate hiking cycle implicit in the current Fed dots, but it does need the prospect of 1 handle on fed funds by the end of 2017.
We stand by a view that the first 5% gain in the broad USD TWI will not be too disruptive for risk in part because the broad USD TWI is close to 5% off its January peak.
Copyright © 2016 DB, eFXnews™Original Article
