meets on Tuesday and a rate hike is as done a deal as these things get. A poll of primary dealers found they all expect a quarter-point rate hike. It is so heavily discounted in the debt markets that the meeting and the rate hike itself have become almost a nonevent, which is arguably what
Greenspan & Co.
Nor is this likely the last hike. In fact, the
fed funds futures strip implies expectations for continued tightening over the next several months. Specifically, the July fed funds futures contract implies expectations for an effective fed funds rate of 6.37%. This means that the market has priced in with 100% confidence, not only next week's hike, but also one after that. And more: The market is saying there is roughly a 50% chance that the Fed hikes again in the first half of this year.
Effectively, this means that the market has priced in a hike at the next two
Federal Open Market Committee
meetings (March and May) and is split about a hike at the June meeting. It is widely understood that the Federal Reserve is loath to inject itself in the national election and therefore will avoid tightening in the month before the November election.
This rules out a move in October and leaves the August meeting as the last opportunity for the Fed to tighten. The September fed funds futures contract implies expectation for an average effective fed funds rate of 6.53%.
Although the timing of the hikes may be important for some market participants, the fact remains that another 75 basis-point tightening has been completely priced in. And because of this, it will be difficult to explain market price action -- such as another correction in the stock market or a stronger dollar -- by citing expectations for Fed tightening. This analysis suggests it is already a "known" quantity and, as you know, the markets respond more to surprises than expected developments.
Policy and Market Movement
The dramatic slide in
through the middle of last week prompted some speculation that it would impact U.S. monetary policy.
First, despite all the ink spilt, the U.S. central bank does not target the stock market. It is an indicator the bank looks at, but there is no evidence whatsoever that the conduct of U.S. monetary policy is driven by equity prices. Indeed, the lack of breadth at least until recently -- which has been highlighted by many observers -- means that the average stock has not performed as well as many of the headline indices. Surely, even if the Fed were to increase the weighting of the stock market in its policy-making equation, it would not single out the relatively small high-tech and biotech sectors, where valuations are thought to be stretched the most.
Just like economists talk about rolling recession -- where the overall economy does not contract but certain sectors slow down, which passes on to other sectors -- maybe we can think about a rolling bear market. This might be defined by a high percentage of stocks falling 25%-50%, while the broad major indices fare much better.
Currencies and Correlations
The dollar did not really suffer much as the Nasdaq was plummeting. The correlation charts that investment banks are sending out are flawed, even sidestepping the whole issue of breadth. Many simply look at the correlation between the level of the Nasdaq or
Dow Jones Industrial Average
and the level of the dollar. They claim high correlations between the Nasdaq or the dollar against the euro or the Swiss franc. However, such correlations break down to levels regarded as statistically insignificant if computed on the basis of the percentage change of the stock market indices and the percentage change in the dollar.
Foreigners, especially Europeans, continue to buy U.S. assets. The U.S. current account deficit, the one doomsayers bemoan, continues to be financed easily and this continues to underpin the dollar. Introductory Economics teaches that a lower price for a good would increase demand. What I want to argue is that this may be wrong when it comes to the euro. There will be more demand for the euro if it can rise above an important downtrend line (drawn off last November and this January's highs) which comes in near $1.00.
Intervention by the
Bank of Japan
last week proved fairly successful, even though it was sterilized and sentiment toward the Japanese economy increased as capital spending appears to have bottomed. Even if it is not as exaggerated as I suspect, repatriation flows ahead of the fiscal year end on March 31 appears to be winding down. Even though preliminary data suggests foreign purchases of Japanese shares in the January-February period is running ahead of last year's pace, the dollar is poised to strengthen further against the yen in the week ahead. Many participants may be reluctant to buy the yen ahead of the results of the Taiwanese elections, which won't be available for a week, given the heightened cross-Strait tensions.
Marc Chandler is the chief currency strategist for Mellon Bank. At the time of publication, he held no positions in the currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at