By Gareth Vaughan
The US Federal Reserve has given financial markets "breathing room," but is still expected to increase its Federal Funds Rate twice this year, says HiFX director of sales Dan Bell.
Early on Thursday morning NZ time the Fed left its target range for the federal funds rate at ¼% to ½%. In interest.co.nz's monthly currencies report Bell said although no rate hike was expected, the Fed's comments were more downbeat and dovish than expected.
"We've seen quite a decent run of economic data out of the US over recent times, the employment situation in the US has been very strong, inflation is starting to tick up there getting closer to that 2% target that the Fed is focused on. We thought the Fed might've been a little bit more upbeat about the economic prospects. But there were certain lines in that (Fed) statement that really underscored a concern with the global outlook, and that has seen the US dollar come under some selling pressure in the immediate response and the market reducing the odds of further rate hikes from the Fed this year," said Bell.
Nonetheless the market is still expecting the Fed to raise rates in the US twice this year, and as many as four times next year.
"Overall we still think the Fed is in tightening mode but today they've given everyone a little bit of breathing room," said Bell.
"Lower rates in the US are positive for risk assets and negative for the US dollar. And there is talk that the Fed and other central bankers have been concerned at some of the US dollar strength that really started around the middle of last year and carried through to the beginning of this year. That hasn't been that favourable for the global economy and naturally you saw a huge sell off in global equity markets and commodity markets at the start of the year," Bell said.
But the market is still positioning for further rate hikes from the Fed this year.
"So I'm not sure I'm going to believe too much of what the Fed is saying today. I think they're giving the market a little bit of breathing room. Ultimately the actual economic data from the US will drive the outlook for rate hikes going through the year. And obviously if the economic data is more positive, the Fed will ultimately respond with rate hikes," added Bell.
Looking ahead Britain will hold a referendum on June 23 on the country's membership of the European Union. Financial markets have worked themselves into a frenzy in recent years over a possible Greek exit, or Grexit, from the EU. Now the talk is of a British exit, or Brexit, but the situation is calmer. Although Britain's a much bigger economy than Greece, the country doesn't use the euro.
Bell said the potential for a Brexit is largely already priced into the pound.
"The risk that the UK leaves the EU has already been factored in, priced in, to the pound. The New Zealand dollar, for example, against the pound is back up around 47 pence, 48p. Towards the end of last year we got down around 40p, so we've rallied pretty strongly off the back of those concerns."
Financial markets like any excuse for a bit of volatility, Bell added, and Brexit risk is an example of this.
"We don't know exactly what impact an exit's going to have for the UK. Obviously it's not really the same situation as Greece where it could trigger a significant meltdown in their financial system. That's not going to be the case. But it will have an impact and financial market participants are factoring in a risk factor to that, which is weighing on the pound and I think that's going to continue."
This means the pound is likely to remain under pressure for the next few months leading up to the referendum given uncertainty around the result.
No 'Trump risk' factor yet
Another factor looking in the not to distant future is the likelihood of maverick contender Donald Trump becoming the Republican candidate in this year's US Presidential Election. (There's a MarketWatch article here on what a Trump presidency might mean for the financial markets). Bell said, however, that the potential of Trump becoming president isn't yet being talked about much in the financial markets.
"It's highly likely that Trump will be the Republican nominee. I think most of us are looking at a (Hillary) Clinton-Trump showdown for the US presidential race, and I think everyone is of the opinion that Hillary Clinton will take that out quite easily given how divisive Donald Trump is," said Bell
"But Trump's not stupid, he plays the game well. So the message and personality he brings to the Presidential race might actually be quite different to what we're seeing in the Republican race. So you could see him start to deliver, perhaps, a more measured and balanced perspective and start to capture some of the more conservative middle class educated vote in the US. It's going to be an interesting and very fascinating year for American politics. But the markets certainly aren't factoring Trump risk, so to speak, to the global economy," Bell said.
Dan Bell is director of sales at HiFX, a UK-headquartered foreign exchange dealer with significant operations in Australia and New Zealand. It has a dealing room in Auckland. See more detail here.