Now that the UK has voted to leave the EU, we have to wonder what will be the Fed's next move. Things have morphed into a worst-case scenario for the Fed. In January of 2016, investors were all but certain of four rate hikes during the year. Not only have the hopes of normalization diminished, in my opinion, but they have also been vaporized. Given the uncertainty that will likely follow the aftermath of the UK vote, the market will be extremely fragile and will look to the Fed for some form of guidance.
Other things to consider in the Fed's path forward are the actions of the ECB and BOJ to improve and stabilize their economies. The BOJ cannot be happy that the Japanese yen as of today is trading at 102 vs. the US dollar. If we go back to the beginning of 2016, the yen was trading at approximately 120 vs. the USD. This is in the face of negative interest rates. I can only see the BOJ getting more aggressive in trying to weaken the yen. Japan is an export economy, and a strong yen does not help its cause.
The Fed will have a tough call, but there are only two options available to it: do nothing or start some form of QE. Cutting the Fed Funds rate 25bps would most likely not have a strong enough effect. In two weeks, we get a jobs report, and a couple of weeks later, we get the 2Q GDP. A weak jobs report combined with a weak 2Q GDP reading and the conversation will quickly begin to shift to a QE-like program.
This is literally now becoming a battle of which central bank can devalue the fastest. This being said, our Treasury rates will continue their downward drift. Selling of euros and pounds will send investors to dollars, and then into our Treasuries.
The BOJ and ECB will ultimately force the Fed's hand into getting aggressive with monetary policy.
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