Dollar: When Will The FED Raise Rates?

Last updated 3/9/2010 5:06 PM ET (GMT -5) 3 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• DOLLAR: WHEN WILL THE FED RAISE RATES?
• EUR/USD: SLIPS AS THE WORRIES SPREAD
• GBP/USD: PRESSURED BY WEAK DATA AND COMMENTS FROM RATING AGENCIES
• AUD/USD: JOB ADS GREW AT RECORD PACE
• NZD/USD: GOLD AND OIL PRICES LOWER
• USD/CAD: HOLDS ONTO GAINS
• USD/JPY: ALL EYES ON JAPANESE AND CHINESE MONETARY POLCIES

EXPECTATIONS FOR UPCOMING FED MEETINGS

DOLLAR: WHEN WILL THE FED RAISE RATES?

The fragmented price action in the forex markets reflect the sharp disparity between what is happening in the North America and Asia with that of Europe.  The dollar traded lower against all of the major currencies except for the euro and British pound.  Growing concerns about fiscal deficits has scared investors from putting their money into Europe because at any point in time, a downgrade could be announced by rating agencies.  Until this risk evaporates, there will probably be more demand to sell euros and pounds.  Meanwhile, last Friday’s better than expected non-farm payrolls report has traders talking about the timing of the Federal Reserve’s rate hike.  With no major U.S. economic developments to talk about today, we thought it would be interesting to take a look at what the market is pricing in for the Federal Reserve this year.

When Will the Fed Raise Interest Rates?

Options on federal fund futures contracts are frequently used to analyze the market’s expectations of monetary policy actions by the Federal Reserve.   The Cleveland Fed publishes this information on a daily basis but their charts only go out to June.  For expectations that extend further, traders usually turn to the Fed fund futures.  According to futures contracts, the market is pricing in a 28 percent chance of a 25bp rate hike in August and a 42.3 percent chance that the rate hike will come in September.  By the end of the year, there is a 68 percent chance that rates will reach 0.75 percent.  Considering that one week ago, there was only a 16.3 percent chance of a quarter point hike in August expectations have increased significantly following the payrolls report.  With these probabilities in mind, traders need to realize that most people only expect one and in the best case two 25bp rate hikes from the Federal Reserve this year.  In other words, there is a very strong chance that interest rates will remain below 1 percent come January 2011.  This is good for the U.S. economy because low borrowing costs encourage investment and spending.  It will also be good for the dollar simply because outside of the Reserve Bank of Australia, the Fed is the only central bank that has toyed with interest rates (albeit the deposit rate only) which suggests that they are the closest to raising rates again.  

Could the Fed Act Sooner?

The next logic question is whether the Federal Reserve could act sooner if non-farm payrolls skyrocket in March.  Given that the first rate hike is expected in the fall, which is realistically not too long from now, we doubt that the Fed would act any sooner even if non-farm payrolls explodes and consumer spending increases significantly.  The U.S. recovery is fragile and problems in different pockets of the world leave a risk of slower global growth.  Fed officials have grown more optimistic but they remain very cautious.  Consumer and small business confidence fell marginally over the past 2 months which indicates that sentiment is delicate as well.  The prospect of gas prices rising beyond $3 a gallon in the spring could also be a concern.  All of these issues will become particularly important on Friday and into next week when the Federal Reserve holds its next monetary policy meeting.  However for the time being, there is no U.S. economic data on the calendar tomorrow which means that the market’s focus will remain on Europe.  

EUR/USD: SLIPS AS THE WORRIES SPREAD

The euro ended the day lower against the U.S. dollar on fresh concerns about Portugal. Almost as quickly as the worries about Greece have subsided, concerns about Spain and Portugal have surfaced. Many people believe Spain could be the next ticking bomb in Europe and now Portugal (another member of the PIGS) could face a downgrade by Fitch due to insufficient consolidation. The problems for the Eurozone never seem to go away and the mere risk of a downgrade of another Eurozone member will keep investors away from euros.  Meanwhile the European Monetary Fund which is the EU counterpart of the International Monetary Fund is set to launch in June.  The fund is designed to avert the problems that the Eurozone faces now where there is no emergency fund to bailout a country like Greece and under the current Maastricht Treaty, an EU bailout of a single country is illegal.  Unfortunately this fund will not be created in enough time to support Greece but it could help to avert similar crises of confidence in the future. The French trade balance was the only piece of Eurozone data released this morning and according to the latest report, the country’s trade deficit narrowed in January.  We expect this same improvement in tomorrow’s German trade figures following the increase in manufacturing PMI.  For the third month in a row, consumer prices in Switzerland edged higher.   The Swiss National Bank has done a good job of capping gains in the Swiss Franc which in turn helped them to beat deflationary pressures.  

GBP/USD: PRESSURED BY WEAK DATA AND COMMENTS FROM RATING AGENCIES

Of all the major currency pairs, the British pound dropped the most against the U.S. dollar. To the surprise of everyone including ourselves, the U.K. trade deficit ballooned in the month of January.  The deficit rose from –GBP 7.01 billion to –GBP 7.98billion.  Exports dropped 7 percent, the largest monthly decline since July 2006.  As the Bank of England noted earlier this week, the weakness of the British pound had a disappointing impact on the economy.  Since the beginning of the year, the British pound has fallen close to 9 percent and over the past 6 months, it has weakened by more than 14 percent.  Yet the sell-off in the sterling not only failed to help boost exports but even cut imports.  Weather may have been a problem but the data was clearly at odds with the export component of the manufacturing PMI report.  This suggests that the export recovery occurred in February and not January.  Meanwhile the RICS house price balance showed fewer gains in prices, which is aligned with the other housing market reports released over the past few weeks.  In addition to disappointing economic data, the pound was also pressured by comments from rating agencies. Moody's said this morning that it could cut the rating of some U.K. banks as stimulus from the government fades. Their current ratings for banks are based on support by the U.K. government and with those measures being phased out they will have to revert to pre-crisis rating assumptions. Meanwhile rating agency Fitch complained about the snail's pace at which the U.K.'s deficit reduction plan is moving. The dovishness of the Bank of England already pushed GBP short positions to record highs and the warnings from rating agencies will only exacerbate the pressure on sterling and push more investors into the safety of U.S. dollars.  The only piece of good news was the BRC retail sales report which showed a pickup in consumer spending; industrial production is due for release tomorrow.

AUD/USD: JOB ADS GREW AT RECORD PACE

The Australian, New Zealand and Canadian dollars ended the NY trading session higher against the greenback even though the rally in U.S. equities faded by the end of the day.  Although commodity prices sold off marginally, the currencies primarily traded off of the relative health of the commodity producing countries.  Australian business confidence rose for the second month in a row while job advertisements grew at a record pace.  There couldn’t be a bigger gap between the Australian and U.S. labor markets.  This is the type of environment where a European Union like agreement would serve Americans well because it would ease the movement of labor, allowing Americans to easily find work in Australia.  Consumer confidence is due for release this evening and based upon the health of the labor market, there is a good chance that consumer optimism grew as well.  New Zealand’s terms of trade are due for release tonight which will be the last report ahead of the Reserve Bank’s monetary policy meeting.  Even though there is no data from Canada, we expect all 3 commodity currencies to continue to trend higher as investors look for alternative opportunities outside of Europe.  

USD/JPY: ALL EYES ON JAPANESE AND CHINESE MONETARY POLCIES

Stronger economic data and concerns about sovereign debt risk in Western Europe pushed the Yen higher against all of the major currencies except for the Aussie, the day’s best performing currency. Positive economic fostered gains in the Yen as the coincidence index, Japan’s broadest indicator of economic health, rose for the 10th consecutive month.  The Index which measures current economic activity based on a composite of indicators that track current business conditions in Japan, rose from 97.4 to 99.9 in January, establishing the longest stretch of improvements since 1997.  However despite today’s optimism, gains may be offset in the near future if the BOJ takes additional steps to ease monetary policy. The policy meeting taking place early next week will potentially be the grounds for the central bank to loosen its policy as officials were cited to favor such move. Nonetheless, all eyes will be focused on Domestic CGPI as deflation continues to eradicate the country’s economy. In the other news, China may tighten their monetary policy as inflation accelerated to a highest level in 16-month period. The following develops a negative nuance for Asia/ Asia-Pacific region which has been a net benefactor of expansion of the world’s third largest economy. China will be releasing their trade figures this evening.  Disappointing results could weigh on the currency market as a whole.

EUR/GBP: Currency in Play for Next 24 Hours

The currency in play for the next 24 hours is EUR/GBP. German Trade Balance and Consumer Price Index will be released at 8:00GMT or 3:00AM EST. Shortly after, Industrial Production will be released from U.K. at 10:30GMT or 5:30AM EST. EUR/GBP is quickly accelerating as it rallies within the Buy Zone established through Bollinger Bands. The next test for the uptrend lies at 0.9150, this year’s high. The uptrend will be negated if the pair falls below first standard deviation at 0.9010.

Comments (3)

Semaj

March 09, 2010 at 05:33 PM ET

K, why are China's news releases not posted in the 360 calendar or other FX internet calendars either?

klien

March 09, 2010 at 06:20 PM ET

Because we don't trade the Chinese Yuan and only recently have Chinese data become more important

HS

March 10, 2010 at 09:38 AM ET

Hi Kathy,
I can recall that you once entered a data table showing the USD performance against EUR, GBP, JPY...... during periods the FED was hiking rates. It would be very interesting to see the past performance which I think was showing a falling USD....Thanks and this is a great site indeed.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.