One day ahead of the all-important Federal Reserve’s decision, the markets are in a consolidation mode. That is, almost all markets!
Currency pairs enjoyed higher volatility levels as last week both the ECB press conference and the NFP in the United States were due. The ECB delivered a hawkish statement, while the NFP was beating expectations across all metrics.
As mentioned above, the ECB delivered a hawkish statement for the Euro, in the sense that, for the first time in a long period, things are not that gloomy anymore. GDP is rising at a nice pace, inflation picks up, and consumer spending is increasing as well.
Moreover, unemployment level is shrinking across Europe and loans to businesses are on the rise. What can go wrong for the Euro?
The answer is the dollar. The U.S. dollar and the U.S. economy is preparing for a new rate hike from the Fed. This rate hike will only make the interest rate differential between the two powerhouses to widen some more.
At -0.5% in Eurozone and 0.75% in the United States, the gap is quite big. Expect it to become even bigger if the Fed delivers.
The NFP last week came after a staggering ADP number that beat expectations by a mile. Pressure mounted that the NFP will print higher as well, and it did, with the unemployment rate further falling to 4.7%.
As part of the Fed’s mandate, the jobs data is crucial for any shifts in the monetary policy. We can say the NFP confirmed the Fed’s hawkishness lately.
It is no wonder, then, that the market is pricing in a 100% probability for the Fed to hike rates. Some will go even further and say that the rate hike is priced in.
This cannot be further from the truth. While the Fed spent a lot of time in communicating the market its intentions, the U.S. dollar’s reaction is unknown. It is one thing to expect something and another thing to see the rates really moving to the 1% level.
Inflation is picking up, the labor market is approaching full employment…it is no wonder the tightening cycle continues. The Fed is clearly looking to stay ahead of the curve, so I wouldn’t be surprised to see a hawkish statement at the press conference to follow the FOMC release.
If that is the case, the U.S. dollar should be on fire. Expect it to have more legs against the GBP, due to the Brexit thing, as this March the U.K. is supposed to trigger the Article 50.