Fed Minutes Take Markets By Surprise

 | May 19, 2016 07:12AM ET

Forex News and Events

Fed minutes take markets by surprise

The Fed’s April meeting minutes have shown that most members of the US central bank are ready to raise at the next meeting. The EUR/USD reacted sharply by declining to 1.1220 before consolidating. Surprisingly, the Fed is again taking a hawkish stance with financial markets practically ruling out a June hike. Before the minutes the likelihood of a June raise was estimated at 4%, now it is up to 32%.

On the back of this release, short-term Treasury yields have increased to a 2-month high to 0.89%. However, in contrast US stock markets ended almost flat as fears of a possible end to the free money era have increased. Nonetheless, we should remember that a raise will only be possible if the economy picks up. The markets which, up to now were firmly focused on global conditions are now thoroughly scrutinising the true state of the domestic economy. Consumer spending, which is on the soft side will be closely monitored in particular. We feel that markets have overestimated any June action and that the dollar should continue to suffer in the run-up to the June meeting. We reload our bullish position on the EUR/USD.

Banxico meeting minutes

With expectations for a Fed rate hike increasing, our focus turns back to the potential reaction in EM currencies. Today Mexico’s Banxico meeting minutes will be released. We suspect that the overall tone will be for banks to maintain a defensive stance, especially given the threats of inflation and FX volatility due to fed policy. Last week Mexico’s CPI decreased 0.32% m/m in April driven by a fall in perishable food prices and FX pass-through. Moving forward, we see a stabilisation of food prices consistent with a year-end inflation forecast of 2.8%. With inflation well mannered, the Banxico will wait-and-see what develops with Fed policy path and commodity prices rather than moving forward with further policy action. Earlier, a surprise 50bp intra-meeting interest rate hike and heavy FX intervention provided the effect of slowing MXN depreciation, without derailing economic activity.

However, should the rally in US yields continue the closer we get to June, the expected weakness in MXN (along with much of the EM space) might demand greater action then just unscheduled FX intervention. Yet, the fear of FX intervention does not seem to be worrying MXN bears. While we do not have a level should the market converge into another “Taper Tantrum” pattern we should see Banxico react with both barrels blazing (surprise FX intervention and interest rate hikes). Elsewhere in the EM, South Africa ‘s SARB is likely to raise repo rate a further 25bp to 7.00% (against consensus of a hold) as CPI inflation levels are expected to climb above target and the weakness in ZAR only amplifies the risks. The concerns are that weak growth dynamics will keep the SARB sideline for now. We remain confident that the Fed will not tighten in June. However, now is not the time to venture into EM currencies.