On 3rd of May this year, The FOMC may announce the last US interest rate hike in the current cycle. According to the March reading, inflation has leveled off and, in just two months, interest rate expectations may have changed 180 degrees.
Source: Tradingeconomics
Is this the last interest rate hike?
The CME FedWatch Tool is a tool developed by the Chicago Mercantile Exchange (CME) to monitor interest rate movements of the Federal Reserve (Fed) in the US. The tool uses the prices of instruments (e.g. futures contracts) in the futures market to estimate the probability of an interest rate hike or cut by the Fed. It currently predicts with an 85 per cent probability that we could see a 25 basis point hike at the next meeting.
Source: CME FedWatch Tool
Interestingly, the market now expects this to be the last interest rate hike. And with as much as 38% probability, the first cut is expected in September or November this year.
Source: CME FedWatch Tool
It appears that the expected level of interest rates above 5 per cent has persisted for two months. After this period, the probability of these rates remaining above this level at the end of this year fell to zero in mid-March. The reason for this development may have been the previously mentioned lower-than-expected inflation readings. This may have additionally caused a decline in the persistently negative yield on long-term bonds relative to short-term bonds for more than nine months.
Source: CME FedWatch Tool
What do the financial markets make of this?
Currently, one of the main indexes likely to be strongly affected by high interest rates is the Nasdaq (US100), an index of technology companies. If the Fed changes its monetary policy, it seems that companies heavily dependent on capital inflows would be able to breathe a sigh of relief. Particularly important for this market appears to be Thursday's US GDP reading and Friday's core inflation reading from this economy. A GDP reading below expectations with a higher fall in inflation could encourage the Fed to cut rates more quickly, which could be good for the index.
Source: Conotoxia MT5, US100, Daily
A potential cut in interest rates could have a weakening effect on the US dollar. As we mentioned, expectations of interest rate rises by the Fed changed in March this year, which could affect the euro or the pound against the US dollar. Currently, real interest rates (interest rates minus inflation) for the economies of the aforementioned currencies are minus 5 per cent and minus 6.15 per cent, respectively, meanwhile in the US they are close to zero. This could be a strong factor for further rises in the listed European economies at the same time as a speculated first decline in the USA. Therefore, in the medium term, the mentioned currency pairs seem to have a strong foundation for continued increases.
Source: Conotoxia MT5, GBPUSD, Daily
Grzegorz Dróżdż, CAI, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
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