Federal Reserve (FED) Chair Yellen testified twice this week in front of a senate committee regarding the semiannual Monetary Policy Report. The market was keen on interpreting her words during the meeting in an attempt to assess the probability of an interest rate hike in the near future.
The conclusion of her two-day meeting: at the very minimum, interest rate hikes will not take place within in the next couple of FOMC meetings. In fact, the very first step – before any interest rate hike occurs – would be to remove the word “patience” in their FOMC communications.
This means that the FED has plenty of time during the year 2015 to review both the economic development in the US and other trends in the world before making a final decision. Therefore any rate hike would probably only occur in the 4th quarter of 2015, at the very earliest, or even in 2016.
CONDITIONS FOR A RATE HIKE
Creating the right conditions for an interest rate hike will be tough. Personally I have strong doubts whether a rate hike will occur in 2015 at all and predict 2016 to be the year of a hike.
- The US economy will need to pick up substantial speed and show growth of earnings and inflation before any rate hike will be implemented. The reason is simple: interest rates have been near 0% levels in the U.S. since December 2008, which means that rates have remained low and flat for more than 6 years. When a trend so well established, the bar for raising rates is high.
- The global trends dominating the markets are a) low levels of interest rates and b) lowering the levels even more. Recently the CAD, AUD, CHF and EUR have decreased rates for instance, plus the EUR and JPY have also added Quantitative Easing (QE). Therefore, an interest hike by the FED not only goes against the US trend but also against the global trend. Easing of credit seems to be the path forward in the near and intermediate future, at least for most of the world. A change in this environment does not seem likely and to go against this global trend is not an easy step to take by the FED.
With the current trends in play, it seems unlikely that the EURUSD can make an extended rally to the upside. The 1.17 resistance would probably be the furthest a bullish movement could go. More Euro weakness can be expected with the European Central Bank (ECB) on the verge of starting its QE program. Depending on how strong or weak the USD data will turn out to be in the next months, the EURUSD downtrend could be less or more amplified.
RATE HIKE EXPECTATIONS
Should an interest rate indeed be implemented by the FED, then the range of the increase should be quite limited considering the previous two points. At the moment a rate hike above 0.75% seems unimaginable, at least within the next two years.
The most likely scenario for two years from now is that the interest rate is (eventually) set at 0.5%, whereas the maximum level is probably 0.75%. The latter can only be achieved if a first raise from 0.25% to 0.50% happens in the 4th Quarter of 2015 or early 2016, after which a second raise from 0.50% to 0.75% would need to be implemented in the later part of 2016. Within the current environment two rate increases seem to be already a tough target, let alone anything more.
What do you think is the most likely scenario? Write down a comment here below!
Tomorrow’s special edition places the interest rates in the main focus by reviewing their historical development, future potential and most likely impact on the Forex Market.
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