Market underestimates FED’s hike intention

At the end of last it would have been fair to say that FED has been overestimating its hike capacity with policymakers projecting 100 basis point hike this year but I think it the market participants this time around, who are underestimating FED’s hike intentions.

Market as of now is pricing first hike to occur in November, hence there would be just one hike. In March meeting, FOMC policymakers already reduced their expectations by 50 basis points, and current expectation of two hikes are quite reasonable. Reason is FED doesn’t want to wait and fall far behind the curve, which will eventually lead to faster rate hikes.

Several policymakers in FOMC already worried of that, namely Esther George, Loretta Mester, and Stanley Fischer. So there could be higher number of dissenters in FED’s next week’s meeting and FOMC may just fall short of that magic majority to raise rates.

Every time, oil price moves up, which is already higher by more than 50% since February and 17% YTD chances of earlier actions from FED moves up. Weakness in Dollar, in addition to oil fastens this trend. Dollar index, which is value of Dollar against a basket of currencies has dropped more than 4.1% this year. Inflation expectations have also moved up and now hovering around highest level since August last year.

Equity markets have recovered completely from their slump. S&P 500 is now up 2.3% for the year.

Interest rates in emerging markets and the currencies have stabilized, even most of them are up against Dollar this year.

China has launched fiscal stimulus, which have stabilized the deceleration for now.

U.S. financial condition have eased significantly and now closer to the level of August last year. According to Goldman Sachs, FCI, conditions have eased more than 100 basis points since late January.

Assessing the above, we feel there is a 50% chance that FED will hike next week and much more than that in June.