Federal Reserve Rate Hike Still Possible Amid Hawkish Sentiments, Sticky Inflation, and Labor Market Tightness
Despite the marginal probability of a rate hike by the Federal Reserve (Fed) in the next three meetings, the possibility remains on the table. This is supported by persistent hawkish rhetoric from Fed officials, continued inflationary pressures, and a tight labor market. Recent revisions to the Q1 GDP figures revealed a slight slowdown in U.S. economic activity, but nothing unexpected.
Inflation and the PCE Price Index
Inflation remains a key concern, with the headline Personal Consumption Expenditure (PCE) Price Index meeting expectations in April. It showed a 2.7% increase over the past twelve months and a 2.8% year-over-year rise in the Core PCE. These figures highlight the ongoing inflationary pressures that the Fed is grappling with.
FedWatch Tool Predictions and Market Sentiment
The CME Group’s FedWatch Tool now suggests there is roughly a 50% chance of lower rates in September. This is influenced by the hawkish tone from the Federal Open Market Committee (FOMC) Minutes and the narrative of prolonged tight monetary policy. Additionally, market expectations indicate nearly 15 basis points of easing at the September 18 meeting, compared to about 35 basis points by December.
Cautious Stance of Fed Officials
Fed policymakers have maintained a cautious stance, bolstering the outlook for a resilient U.S. dollar in the coming months. Minneapolis Federal Reserve Bank President Neel Kashkari emphasized the need for significant progress in reducing inflation before considering interest rate cuts. He even suggested the possibility of raising rates if inflation does not decrease further. Similarly, Federal Reserve Bank of New York President John Williams stated there is no immediate need to cut interest rates, noting that the Fed has the flexibility to gather more data before making policy changes. Chicago Fed President Austan Goolsbee indicated that further improvements in inflation might result in higher unemployment, while Dallas Federal Reserve Bank President Lorie Logan expressed confidence that inflation is on track to reach the Fed’s 2% target.
Trends in U.S. Yields and USD Performance
The performance of the U.S. dollar aligned with a rangebound theme in U.S. yields across various timeframes, influenced by a shifting macroeconomic backdrop that has reduced the likelihood of rate cuts in September. Yields have remained around the upper end of the monthly range, reflecting the ongoing uncertainty and cautious optimism.
G10 Central Banks: Rate Cuts and Inflation Dynamics
Examining broader trends among G10 central banks, the European Central Bank (ECB) is anticipated to cut rates next week, although there is significant uncertainty about subsequent cuts. The Bank of England (BoE) is likely to reduce rates in the last quarter, while the Fed and the Reserve Bank of Australia (RBA) are expected to start easing by the end of the year. This global trend underscores the widespread challenges central banks face in balancing growth and inflation.
Upcoming Key Economic Events
Next week, all eyes will be on the release of May’s Nonfarm Payrolls, which will be a crucial indicator of labor market health. This will be followed by the ADP employment report and the ISM Manufacturing and Services PMIs, all of which will provide further insights into the state of the U.S. economy.
Technical Analysis of the USD Index
The USD Index (DXY) is currently consolidating between 104.00 and 105.00. A break above the weekly high of 105.74 (May 9) could pave the way for a move towards the 2024 peak of 106.51 (April 16). If this level is breached, it might lead to the November high of 107.11 (November 1) and the 2023 top of 107.34 (October 3). On the downside, renewed selling pressure could bring the DXY back to the May low of 104.08 (May 16). Further declines might see the index test the weekly low of 103.88 (April 9) and the March bottom of 102.35 (March 8). A deeper retracement could target the December low of 100.61 (December 28), the psychological barrier at 100.00, and the 2023 low of 99.57 (July 14).
Broader Market Perspective
From a broader market perspective, the overall bullish bias for the USD Index is expected to persist as long as it remains above the 200-day Simple Moving Average (SMA) at 104.42. This suggests that the market continues to have confidence in the dollar’s strength, despite the potential for rate cuts later in the year.
Conclusion
In conclusion, while a rate hike by the Federal Reserve in the next three meetings is seen as marginally probable, it remains a possibility due to persistent hawkish rhetoric, sticky inflation, and a tight labor market. The FedWatch Tool reflects a cautious market sentiment, with a significant chance of rate cuts by the end of the year. Fed officials’ prudent stance and the global trend of anticipated rate cuts among G10 central banks highlight the complex economic environment. Upcoming key economic events will provide further clarity on the U.S. economic outlook, while technical analysis suggests a bullish bias for the USD Index as long as it stays above its 200-day SMA.
