July Fed rate hike expectations jump to 74%

BY Janne Muta

|June 19, 2023

The Fed is prepared to tighten the lending conditions further to bring inflation down. This has pushed the expectations of a 25 bp hike in July to 74 and brought in some USD buying. However, due to a US bank holiday trading in the markets could be more subdued today so the reactions to the higher expectations are likely to fully play out from tomorrow onwards. Equity index futures are trading but as the stock exchanges and bond markets are going to be closed in the US session the big institutional investors are not likely to be active today for liquidity reasons. Therefore, we’ll be taking a look at fundamentals and this week’s macroeconomic data releases.

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Fed Chair Powell speaks to US lawmakers on Wednesday and Thursday and is likely to once again talk the rates higher (and bonds lower) by convincing the markets that two more quarter-point rate hikes are needed. Powell’s message to Congress has been published on Federal Reserve’s website and follows along the lines of Powell’s earlier message last week. Here’s an extract that summarises his message:

“Although inflation has moderated somewhat since the middle of last year, it remains well above the Federal Open Market Committee’s (FOMC) objective of 2 percent. The labor market continues to be very tight, with robust job gains and the unemployment rate near historically low levels, though nominal wage growth has shown some signs of easing and job vacancies have declined.

Real gross domestic product (GDP) growth was modest in the first quarter, despite a pickup in consumer spending. Bringing inflation back to 2 percent will likely require a period of below-trend growth and some softening of labor market conditions.

In response to high inflation, the FOMC continued to increase interest rates and reduce its securities holdings. The FOMC has raised the target range for the federal funds rate a further 75 basis points since the start of the year, bringing the range to 5 to 5¼ percent.

In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the FOMC indicated that it will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. The Federal Reserve also continued to reduce its holdings of Treasury and agency mortgage-backed securities; these holdings have declined by about $420 billion since January, further tightening financial conditions.”

To summarise, the Fed is prepared to tighten the lending conditions further to bring inflation down. This has pushed the expectations of a 25 bp hike in July to 74%. That’s the probability the Fed Fund Futures traders have priced in that the target range will be 5.25% - 5.50% after the next FOMC meeting on July 26th. As a result, there has been some USD buying after three weeks of decline while risky assets (mainly commodity currencies and equity indices) have lost upside momentum.

The Bank of England meets on Thursday. The market expectation is that the BOE will hike at least by 25 bp. while some anticipate an even higher, 50 basis points hike as inflation has remained rather high wages are surging.

On Wednesday we’ll hear from Office for National Statistics as they report the latest inflation numbers. The numbers and the subsequent market reactions are likely to impact the BOE decision. The analyst consensus number for the headline inflation is 8.4% (8.7% prior).

Friday will be dominated by PMI data releases from the major European economies and the US. German manufacturing PMI is expected to come in well below the crucial 50 mark and if the weakness in China continues we should expect more of the same in Germany in the future too.

The country isn’t, however, facing a contraction in the industrial sector alone. The EU-wide manufacturing PMI as well as the French and UK PMIs are expected to come in at levels that signal contraction.

While the US manufacturing sector has been the strongest it too has been contracting. High inflation, a slowdown in China and Russia’s war in Europe with the economic sanctions still firmly in place are likely to weaken, especially the European manufacturing sector.

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GBPUSD has rallied on rate hike expectations. Keep an eye on the market reaction to the inflation numbers release on Wednesday to gain insight on whether the market participants believe the BOE will hike by 25 or by 50 bp.

The market has been able to create higher lows and has broken above a key resistance level (1.2680). The nearest key support levels to focus on are 1.2486 and 1.2680. The market stays bullish above 1.2308 in the weekly chart and could trade up to 1.3210. Below 1.2308, the market would probably trade down to 1.2200.

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Gold has stabilised above the 1925 level and is trading in a sideways range (1925 - 1985). There’s been a downside drift in the market though and if the Fed rate hike expectations start pushing the dollar higher we might see further weakness in gold.

Currently gold remains bearish below 1968. Above the level, look for a move to 1983. Below 1968 the market is likely to trade down to 1925. Should the market move outside the range boundaries, we’ll update you on the moves the gold might make.

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Dow Jones Industrial Average

Dow rallied to a weekly resistance level last week On Friday the move above the level was rejected as traders took some profits off the table after a three-week run higher. Now that the Fed rate hike expectations have jumped to 74% the risk of further softness has increased.

The big picture in Dow is bullish though. The market has created a higher swing low (32 582) which indicates strength and could eventually lead Dow higher. Below, the level the current upward weekly trend would not be in force and the market could trade down to 31 850. In the daily chart, the market remains bullish above 33 772 and could test the key resistance at 34 931.

The next main risk events

  • All - US Bank holiday today
  • AUD - Monetary Policy Meeting Minutes
  • GBP - CPI
  • CAD - Core Retail Sales
  • CAD - Retail Sales
  • USD - Fed Chair Powell Testifies
  • CHF - SNB Monetary Policy Assessment
  • CHF - SNB Policy Rate
  • USD - FOMC Member Waller Speaks
  • CHF - SNB Press Conference
  • GBP - MPC Official Bank Rate Votes
  • GBP - Monetary Policy Summary
  • GBP - Official Bank Rate
  • USD - Unemployment Claims
  • USD - Fed Chair Powell Testifies
  • USD - Existing Home Sales
  • GBP - Retail Sales
  • EUR - French Flash Manufacturing PMI
  • EUR - French Flash Services PMI
  • EUR - German Flash Manufacturing PMI
  • EUR - German Flash Services PMI
  • EUR - Flash Manufacturing PMI
  • EUR - Flash Services PMI
  • GBP - Flash Manufacturing PMI
  • GBP - Flash Services PMI
  • USD - Flash Manufacturing PMI
  • USD - Flash Services PMI

For more information and details see the TIOmarkets economic calendar.

Trade Safe!

Janne Muta
Chief Market Analyst

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Janne Muta

Janne Muta holds an M.Sc in finance and has over 20 years experience in analysing and trading the financial markets.

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