Questions about a Fed rate hike in June were not answered by Federal Reserve Chair Janet Yellen last week, and now Mr. Market seems to think there won’t be one. The U.S. dollar’s value and the foreign exchange markets are now up in the air, although the dollar may not surge sharply anytime soon, believe strategists at Deutsche Bank.
Mr. Market believes a June Fed rate hike isn’t in the cards
David Bianco and Winnie Nip said in their March 18 report titled “Central Bank Chess: Every action has a market and/or other policy reaction” that the markets now seem convinced that the next Fed rate hike won’t come until September. They added that it appears that the markets are expecting one in December as well. In last week’s press conference, Yellen cited global risks as major concerns right now while avoiding giving any indication about a Fed rate hike in June.
However, the Deutsche Bank team notes (as have others) that the job market has remained solid. Also the euro has stabilized because the European Central Bank has cut down the risk that the currency war will escalate.
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“Does the Fed know what an open window looks like?” they ask rhetorically, adding that they thought Yellen would have opened the door to hiking rates in June.
Further, they interpret the Mr. Market’s reaction to Yellen’s comments as an indication that investors continue to believe that the next two Fed rate hikes will be in September and December rather than June and December. They note that following her comments, the dollar declined while commodities rallied and June Federal Funds futures plunged. It should be noted that other firms, such as Macquarie, are still expecting three hikes this year.
S&P 500 rally justified
After a brutal start to the year, the S&P 500 has staged a tremendous rally over the last five weeks, and the Deutsche Bank team now sees the index as being fairly valued. They don’t expect the dollar to surge in the near term because the Fed cut its rate forecasts for this year and next and the European Central Bank appeared to acknowledge that negative interest rates and currency devaluation aren’t working.
They stop short of turning bearish on the dollar though, and they “wish” Yellen had prepared the markets for a Fed rate hike in June, which they see as “highly possible.” If she had, they could have seen what the foreign exchange market would do to such comments. Further, she said if there is no Fed rate hike in June, they’re unsure of how the ECB and Bank of Japan would be of currency appreciation.
In terms of the stock market, they don’t see a June hike as triggering a correction, although they think Energy and other stocks that are sensitive to commodity prices will fall while Bank stocks climb.