Global weekly: Aren’t markets ‘Fed up’ yet?

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Speculations around policies of the major central banks hold sway of financial markets for a while now. Expectations have risen that the Fed may lift its interest rate in December. Bond markets retreated this week, whereas equity markets continued to recover.

Macro outlook

The US dollar (USD) strengthened this week against most major currencies, due to expectations that the US Federal Reserve (Fed) could hike interest rates in December. This was because US economic data surprised positively and Fed members hinted at a rate hike.

In October, the expansion of the non-manufacturing sector accelerated. The new orders and employment sub-index also rose. In addition, the trade deficit narrowed in September. Comments from Fed Chair Janet Yellen and Fed member Dudley that raising interest rates in December remain a ‘live possibility’ also supported the US dollar. Friday afternoon, the US Employment report came in much better than expected and this pushed up the US dollar across the board.This strong employment report further increases the likelihood of a rate hike in December.

After this strong employment report, financial markets are pricing in a probability of almost 72% that the Fed will raise the Fed funds rate, its main policy rate, by 25 basis points (bps) at the December meeting, compared with a probability of 50% a week ago.

The increased probability of a December rate hike led to a stronger dollar, which also means tighter financial conditions. Moves from other central banks to ease monetary conditions, will likely put additional upwards pressure on the USD. We have seen in the past months that the impact of a strong dollar has made its way to weaker export growth and has had a negative impact on export-related manufacturing activity. Our year-end forecasts for 2015 and 2016 for EUR/USD are 1.10 and 1.00, respectively, reflecting the start of the hiking cycle next year.

It remains to be seen whether the pricing of an earlier rate hike negatively impacts sentiment and leads to a renewed tightening of financial conditions. Our base case is that a hike will be delayed to 2016, but chances of an earlier move have risen.

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