The fallout from the Fed minutes

So, the minutes were considered dovish, which is no surprise since the meeting at the end of July allowed an element of doubt to be thrown in about the prospect of a rate rise next month. The build up to the first rate hike from the US is starting to get tortuous, the market wants clear direction from the Fed, but the Fed is resisting it. Our view is that the decision will come down to the wire, with the market lurching at key employment, wage and inflation data between now and then.

The actual damage done from these minutes is a shift in Fed Funds futures. The Fed Funds futures market is now pricing in a mere 38% chance of a rate hike next month, compared with more than 80% of economists polled by Bloomberg looking for a rate hike. The market is a bit more optimistic of a rate hike in December, with a 66% chance of a move. However, recent events including a sell-off in stock markets and the Chinese currency devaluation has made the market less sure of a rate rise in 2015, and more likely to put their money on a rate rise in Q1, where there is an 83% chance of a rise according to Fed Fund futures.

This is significantly lower than expectations earlier in August, as you can see in the chart below, when the Fed Funds futures was pricing in a 55% chance of a rate rise on the 17th September FOMC meeting.

From a market perspective, this caution on the prospect of a rate hike next month may trigger some interesting market developments in the next couple of weeks:

• It could weaken the dollar index, which is testing a cluster of moving averages at 96.40. Below here opens the way to 94.60 – the 200-day sma – and also the lowest level since June.

• A weaker dollar could fuel a short term recovery in commodity prices, Bloomberg’s commodity index is at its lowest level since 2002, and oil looks desperately oversold.

• If commodity prices rally then it could be an Indian summer for commodity FX bulls.

• It could keep the EUR above water. EURUSD has been stubbornly range-bound around 1.10 and has not fallen as much as expected. A weaker buck could support EURUSD downside in the next few weeks, with 1.0850 a medium-term support level. A break above 1.1220 – the high from 12th August – is a bullish development that opens the way for more late summer upside from the euro.