February 20, 2017
French corporate and investment bank Natixis suggested on FXStreet News that there is a 44% chance of the first of the rate hikes next month (up from 24% last week). Natixis still maintains its view that the first of the hikes is likelt to come in June, however if they keep seeing positive surprises on the inflation metrics, they could revise this.
The issue that faces the Federal Reserve is that if it does not hike rates in March, key European elections in March, April and May could result in more pro-populist, anti-establishment results which would effectively tie its hands until June.
The Elephant in the room is once again Greece and its looming debt payments in July. For Greece a negotiation is needed, not an asset grab by its European cousins. For its EU creditors, this is something that they are unwilling to do, which is putting them on a direct collision with the IMF, which wants to see more debt relief and easier targets before it commits to any further bailouts.
If they fail to come to terms by July we could once again see a possible Grexit – of the Euro, not the European Union – rearing its head.
Yellen has previously held off committing to raising interest rates on the basis of European economic uncertainty. A Greenback that is getting increasingly stronger could temper the Fed’s ‘three-hike’ ambitions as Trump’s economic policies clearly point to a stronger dollar, again, creating uncertainty for the Fed.
Last year the Fed targeted four hikes and failed to achieve them. If they don’t hike in March, then it is likely they will fail to reach their targets for a second year running.
Currencies, debt, equities and commodities will all be affected by the uncertainty in the markets. More pro-populist votes do not by themselves signal the breakup of the EU, but they will mean reform at the very least, with potential referendums if this is not achieved.
A failure by Yellen to raise rates in March would suggest three rate hikes by year end are off the table – not to mention a potential clash between the IMF and the EU.
For the money markets which try to make money from market movements, the big question is what does this all mean?
Directionally, a weaker Euro should push equity valuations up in the near term. For commodities that correlate to the US$, things will become increasingly unclear if the Fed does not hike rates next month. What we do know is that market uncertainty and volatility go hand in hand, and this is where the clever money will be heading.
Option volatility should be the hedge of choice for many institutions. If there is ever a time to buy the rumour and sell the fact, then option volatility could be the place to be.
So there may be trouble ahead, but this may not come to fruition. However, the potential uncertainty should be enough to push implied volatility levels higher.