Fed outlook

The market has agreed that the Fed will not hike interest rates this year and will raise rates only once or twice next year. That might seem to be all that is relevant for the FX market on this subject. However, it is not quite as simple as all that. 

It does not just matter that from the market's point of view the Fed will not take any steps but also why it will leave interest rates unchanged. The reports from the news agencies this morning contain the clever statement from one analyst that commodity currencies were too strong. 

"Strong commodity currencies would suggest to the Fed that (from the market's point of view) the flaring up of EM risks had been overcome and that therefore the path towards Fed rate hikes is cleared again. However, if the Fed does hike interest rates after all the commodity currencies will get back under pressure", says Commerzbank. 

However, this logic is based on the assumption that the Fed would adjust its policy to the risk sentiment of the market, so would react to falling EM risks with an increased tendency towards rate hikes. Not a completely implausible assumption. After all that is exactly what the Fed is saying. 

However, the market is now dominated by a different view of the US central bank. The view that the FOMC does not want to hike key rates anyway. No matter what happens in the world. And that all the forward guidance was only aimed at disguising this approach. 

Hardly anyone will admit that publicly. But the fact that neither the Fed Fund Futures nor the USD exchange rates recently reacted to US data constitutes important evidence of my view. 

If that is the currently dominant market view, the above is not right as in that case strong commodity currencies do not increase the likelihood of a Fed rate hike.