Dollar Bulls Ask 'When Will The Fed Hike?'

Published August 27th, 2008 - 11:51 GMT

The Fed minutes released this passed week confirmed what the market has been pricing in for some months now: the next move in interest rates is likely to come in the form of a rate hike. However, for dollar traders, the operative question is not whether the policy board will hike or cut, but rather when.




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CREDIT MARKET: HOW IS IT DOING?

The Fed minutes released this passed week confirmed what the market has been pricing in for some months now: the next move in interest rates is likely to come in the form of a rate hike. However, for dollar traders, the operative question is not whether the policy board will hike or cut, but rather when. Fed Fund futures this week have maintained the steady decline in speculation for a hawkish move anytime time this year. The derivatives show the market is pricing in a 90 percent probability for the September 16th's meeting to pass without incidence and a more intense 78 percent likelihood that the benchmark will still be at 2.00 percent through year’s end. With the dollar pushing 8 month highs after staging the biggest rally in over three years, forecasts will need to find solid fundamentals to maintain such heights. However, with inflation cooling and financial problems growing, a hike seems distant.

A DEEPER LOOK INTO THE CHANGES THIS WEEK:

US credit markets (like those across the globe) are in a state of wait-and-see. This past week, fears that another liquidity crunch may come in before the year is through spiked thanks to an unwavering focus on the some of the more troubled American banks and major lenders. Ironically, just after an ex-IMF chief forecasted another Bear Stearns-level collapse, Lehman Brothers reportedly failed to sell half of a new offering to Asian investors. Far more troubling to the market though is the speculation that Fannie and Freddie may need to be bailed.

While risk measured through the credit market continues to grow, the demand for yield seems to be keeping up. With yields measured through the junk bond spread and CDSs rising, there has been little movement in short-term money market and Treasury rates. Nonetheless, risk and the potential for another plunge in short-term debt does remain as liquidity problems persist – potentially setting up the next credit crunch. Reflecting the difficulty, the Fed’s recent $75bln TAF received $84.17bln in bids and the FDIC ‘problem list’ is now at a five-year high.

 

 

FINANCIAL MARKETS: HOW ARE THEY DOING?

When the Federal Open Market Committee meets in three weeks, they will almost certainly keep their reference to concerns over the health of the financial markets. In the recently released FOMC minutes, the policy authority made reference to a fragile market and said that raising capital was growing increasingly difficult. With consumer spending slowing, commodity prices finding an equilibrium at historically high levels and the availability of liquidity contracting, the outlook for corporate revenues and investment trends is in jeopardy. From the same period a week ago, the benchmark stock indexes are little changed after breaking a steady (albeit modest) rising trend. Elsewhere, debt markets are reflecting gaps in liquidity and less the outlook for the economy. Only commodities have found significant strength – which is in turn detrimental to the health of the broader investment arena.

A DEEPER LOOK INTO THE CHANGES THIS WEEK:

Stocks have been relatively mixed over the past week as the tailing end of the second quarter earnings season offers little distraction from the concern centered on the health of the banking and lending groups. The financial sector is currently suffering from its worst slump since 1962; and conditions aren’t likely to improve until there is resolution in the Freddie Mac/Fannie Mae situation and ailing banks prove their solvency. Third quarter earnings may be the next milestone.

Market condition indicators have stabilized over the past week. The range bound activity in the benchmark stock indexes and the congestion from volatile commodities (until recently) has led the VIX index to peak around 21 percent. After topping out recently, there is now a clear descending trend in the indicator. As for the directional put-call ratio, the rabid buying of protective puts was snuffed out as the investors’ fears calmed with time producing no major reversals from the Dow 30 and other indexes.

 

 

 

U.S. CONSUMER: HOW ARE THEY DOING?

Economic data released over the past week related to the health of the American consumer seems to point to a brighter future. However, the promising headline figures may be just a glossy façade to ongoing economic troubles. Data this past week suggested a rise in existing and new home sales (improving the outlook wealth) as well as a rise in the consumer confidence gauge (boosting expectations for spending). However, we need to remember that the housing data is merely rebounding from 17-year lows and inventories are pushing record highs even though prices continue to tumble. For the sentiment gauge, the current conditions figures have pushed to new lows and the headline reading is just off of multi-decade lows. In the second half of 2008, the consumer is still expected to be a burden on GDP. We will look to the 2Q revisions to see if they are becoming a drag earlier than expected.

A DEEPER LOOK INTO THE CHANGES THIS WEEK:

The most timely consumer-related indicators merely confirm the veiled trouble mentioned above. Measuring the direct health of the American citizen, the ABC sentiment gauge slipped to match its lowest reading in three months as the reading on personal finances and the buying climate both slipped to new lows. For greater historical reference, this gauge is just off its recent record low set back in May. Elsewhere, wealth and income are falling fast. Building permits improved modestly from seven year lows – suggesting a turn in housing is still a long ways off. Also, the four-week moving average for initial jobless claims (less volatile) pushed to a new seven year high. This promises a disappointing NFPs next week.

The economic outlook for the world’s largest economy seems to be on the path of redemption; but data doesn’t support the optimistic outlook that has permeated the dollar. As traders reference the better than expected reports from housing, confidence and other indicators, it seems that there is no thought to that fact that these figures are merely ticking higher from multi-year lows. It will be important to see how the second quarter GDP revision fairs on Thursday. Expectations are looking for a hefty increase to a 2.8 percent clip. Contradicting this forecast though, we have seen the forward-looking Leading Indicators composite drop 0.7 percent (the most in a year) on readings for employment, construction and the health of capital markets.

 

Written by: John Kicklighter, Currency Strategist for DailyFX.com
Questions or comments on this or other reports authored by John? You can email them to jkicklighter@dailyfx.com.

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