Markets Wag the Fed

Several times after the global financial crisis, the markets went to a sharp peak, fearing the collapse of incentives.
Alexander Kuptsikevich
The Federal Reserve

The Fed has a difficult balancing act. On the one hand, the market should not be allowed to dictate its terms, because low rates are in the interests of the stock market and generally increase the economic growth. On the other hand, the Reserve system is always predictable for the markets with its rate policy and QE decisions. Volatility is usually causing by a tone of comments in relation to future FOMC plans. Fed leads market expectations by its forward guidance, but sometimes it seems that the “tail is trying to wag the dog”.

Several times after the global financial crisis, the markets went to a sharp peak, fearing the collapse of incentives. As a result, the Fed gradually adjusted its position, which was very much like blackmail. Something similar we saw at the end of last year.

From an economic point of view, it is impossible to believe in the probability of lower rates this year: although markets are 40% sure of the likelihood of such a scenario. All of this – on the background of incredible national statistics: the Unemployment rate is at a minimum for many decades: Wages and Expenses are growing at a level that has not been observed for many years. Industry, as well as the service sector, has recently registered the perennial growth rates. It is quite natural, that now we see some slowdown in these branches: the more so due to the price fall of raw materials. However – and it is necessary to make an accent – these changes return rates of growth to the trend levels, and nothing more. We can’t seriously talk about looming stagnation or even recession.

The dynamics of the debt market (it indicates the national rates decline) should be explained not only by forecasts of the market participants but by short-term positioning: at the end of the year, investors were actively withdrawing money from emerging markets, buying short-term papers as “cash”. Due to such high demand, the price rose and the yield declined.

Right now, the behavior of investors is somewhat discouraging. A year ago, debt markets expected 2-3 increases, and the Fed confidently adhered to a plan for 4 rate hikes. We saw that the economy was strong enough to keep growth above average, despite the tightens.

Again, it is hard to believe that the market forecasts are closer to reality than the expectations of the Fed. Therefore, in the near future it is necessary to expect a revaluation of expectations, and also some rebound of short-term U.S. bonds yield and, as a result, strengthening of the American currency.

Among the important levels, it is worth to pay attention to the 1.15 level, which the pair EURUSD cannot pass during the last two months, as the markets pick up the dollar on the dips. If our assumptions are correct, from these marks the dollar is fully able to develop its growth.

 This article was written by FxPro

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