March FOMC rate hike looking more likely now – MUFG

Derek Halpenny, European Head of GMR at MUFG, suggests that it’s now over to the Fed and with the financial markets increasingly pricing in the probability of a rate hike in March, there is certainly a much greater chance that Yellen’s speech on Friday may well support that logic.

Key Quotes

“Why would Yellen at this stage attempt to reverse market pricing given the FOMC have signalled there will be three rate hikes this year even before we know for sure what fiscal stimulus will look like? The latest to shift the market was San Francisco Fed President Williams who stated that a rate increase was on the table for “serious consideration” at the March meeting. St.Louis Fed President Bullard also called for the immediate end to the reinvesting maturing securities on the balance sheet of the Federal Reserve.”

“How has market pricing changed? It’s been pretty dramatic in fact. The March Fed Funds futures contract by our calculation is now indicating a market probability of 70% for a March hike. Three days ago the probability was just 23%.”

“There are perhaps three events to focus on between now and the FOMC meeting – the core PCE inflation report today; the Yellen speech on Friday; and the payrolls report on 10th March. The inflation data today is unlikely to be hugely surprising while assuming the speech by Yellen keeps the markets open to the idea of March it would take a hugely disappointing jobs report to alter market expectations.”

“We now see a much greater chance of a rate hike this month than just a few days ago given our argument in part for the move coming in May was that market pricing was not high enough. With that now having changed, we see less reason to argue for a delay beyond this month.”

“That will ensure the dollar continues to advance over the coming days and assuming Yellen does not wish to alter market pricing then through to the meeting itself and beyond if a hike takes place. Our call of EUR/USD breaching parity remains in place with the 2-year swap spread in favour of US rates breaking to new highs consistent with EUR/USD breaking below the 1.0400 level. Action from the Fed in March could have quite a dramatic shift in market expectations and the rates curve could undergo quite a notable shift higher as the prospects of four rate hikes at each press conference meeting becomes more plausible.”