The Feds may have to argue, but the FX market thinks a rate hike is starting to appear far more likely

Outlook

The stock market slip yesterday delivers the signal—rate cuts are probably off the table. Mr. Warsh was approved to take over from Powell and faces the ugly prospect of having to tell Trump, no, he can’t have a rate cut. Even if he wanted to deliver a cut as a reward for being named to the top of the Fed, he is but one vote.

What Warsh actually says in public will be important. He has expressed a preference for the trimmed mean version of inflation, but as noted yesterday, the Cleveland Fed’s version has already shown the biggest gain since Jan 2024 at an annual rate of 2.8%. To add insult to injury, inflation has been above the Fed’s 2% target for 62 consecutive months. You can’t jigger the data to make that go away. 

So, a tough row to hoe for Warsh.

The Feds may have to argue, but the FX market thinks a rate hike is starting to appear far more likely. The CME Fedwatch probability of a hike at the Sept meeting was 2% a week ago and 9.46% as of last evening. By the Dec meeting, one hike has a probability of 29.9% + 4.5% for two + 0.2% for three or 34.6%. We can expect these numbers to keep rising as conditions worsen, as they most surely will unless the Strait of Hormuz is re-opened and PDQ. 

Today we get the PPI for April, expected at 4.8% in the headline (from 4.0%) and 4.3% in the core (from 3.8%). PPI doesn’t usually scare the horses but has the power to do so this time. Tomorrow it’s the usual jobless claims, with some hope riding on a good report. 

So far the stock market is dealing only with the prospect of no rate cuts and not with the idea of hikes. It’s the fixed income and FX markets starting to build in the hikes. To be fair, equities have been driven more by earnings and tech stories than by the interest rate environment, so there is little reason to think a hike or two is harmful.

For currencies, there is an element of irrationality here—others are going to hike sooner and in the end, by more. But never mind—it’s the Fed that counts, at least until something else comes along. That something else is likely geopolitical—Trump dismantles the informal Taiwan agreement, for example, or goes back to bombing Iran. Then risk aversion favors the dollar independent of the economy.

There are some side-stories. The emerging market currencies, just recently resurrected, may see a loss of favor. The pound is vulnerable for domestic political reasons. The vigor of the opposition to PM Starmer bodes ill. And Japan, loathe to hike but suffering from a too-weak yen, is up the creek without a paddle. The dollar/yen is moving up again and it would seem that intervention or even jawboning would fail and cause a loss of face.

Forecast

We got the trigger for a reversal of fortunes in FX—US inflation.  For the moment, it outweighs the war stand-off and other factors. We detected a dollar resurgence from pure fatigue over flattish price movements, but good, hard data is always better.

When you have inflation, rising energy prices, rising rates and robust growth, it’s hard not to see the dollar on the upswing. For the near-term, anyway. 

Tidbit: Asked to what extent the economic strain on Americans was motivating him to strike a deal, Trump replied: "Not even a little bit. I don’t think about Americans’ financial situation. I think about one thing: We cannot let Iran have a nuclear weapon."

Fun Tidbit: From Bloomberg last evening:

“India has raised import tariffs on gold and silver in an attempt to curb bullion purchases and defend its currency, as it grapples with the fallout from the Middle East war.

“The government has effectively more than doubled the tariffs on gold and silver imports to about 15% from 6%, according to two official orders, imposing a 10% basic customs duty alongside a 5% agriculture infrastructure and development levy.

“The higher import taxes will likely damp demand for the precious metals in the world’s second-biggest bullion market and help ease the trade deficit. The duty hikes follows Prime Minister Narendra Modi’s unusual appeal for Indians to forgo gold purchases for at least a year to preserve foreign-exchange reserves, as soaring energy prices hurt the economy.”

Yesterday Bloomberg reported this was expected as an emergency step to protect FX reserves. “Officials are concerned about the widening current account deficit and the measures are aimed at curbing imports to preserve foreign exchange. The RBI has been steadily intervening to bolster the currency, with foreign exchange reserves dropping to a certain level, and the central bank could change rules on currency hedging for importers.”