The first week of June was chock full of economic and monetary data. In the U.S., the end result was an S&P 500 (NYSEARCA:SPY) that managed to lose 0.7% for the week.
More importantly, the market's implied odds for a first rate hike from the U.S. Federal Reserve finally moved up by one meeting. After Friday's strong non-farm payrolls number, the 30-Day Fed Funds Futures printed a 50.1% chance for an October rate hike. The odds for a rate hike increased for every month through January except June which remained at 0% (even as some notable talking heads on CNBC insisted that the Fed must hike rates this month). The odds are also now higher than they were a month ago. In other words, the market is gearing up further for an imminent rate hike.
In the charts below, I show the progression of probabilities for the week (excluding Thursday) to show how the unfolding economic data seemed to move the futures market. I exclude June since it never moved from 0%. The x-axis shows the month of the Fed meeting. The y-axis provides the odds of a rate hike at the Fed meeting for that month. From left to right for each given Fed meeting month, the three bars quantify the odds of a rate hike for a month ago (NASDAQ:BLUE), the previous day (red), and the day shown in the chart's title and legend (green). The odds for the previous day sometimes vary a bit from the odds I recorded on that day because of my timing: sometimes I recorded the numbers shortly after the close of U.S. trading, sometimes I recorded it later in the evening. The CME updates the odds every 15 minutes.
Fed Funds Futures after ISM and construction data
Fed Funds Futures after factory orders data
Fed Funds Futures after ISM non-Manufacturing data
Fed Funds Futures after non-farm payrolls
Source: CME Group 30-Day Fed Funds Futures?
With the odds of a first rate hike moving from December to October (meaning the month where the odds are first better than 50/50), one might expect the U.S. dollar index (NYSEARCA:UUP) to soar. While the index did jump off its lows for the week, it ended the week down 0.6%. The index has also only gained 1.3% over where it traded a month ago when the odds for an October hike were only 39%. The U.S. dollar remains underneath the downtrend from the March multi-year highs and underneath a now declining 50-day moving average (DMA).
U.S. jobs data reawakens the U.S. dollar but overhead resistance remains firmly in place
The parallel weakness in the U.S. dollar and the S&P 500 was a reminder that the relationship between the two is not consistent and not very tradeable. Moreover, events in the eurozone reflected heavily on trading in the U.S. dollar. In particular, financial markets over-reacted to stronger than "expected" inflation numbers in the eurozone. The chart above shows the euro's impact on the dollar index after the inflation data. The euro (NYSEARCA:FXE) further strengthened against the U.S. dollar in the wake of the European Central Bank (ECB) issuing its latest statement on monetary policy on Wednesday. The U.S. dollar index bottomed for the week on the following day.
The next U.S. Fed decision comes on June 17th. While the Fed is extremely unlikely to surprise markets with a June rate hike, the U.S. dollar should still prove particularly sensitive to hints on timing. October is only 4 months away, and the odds for a rate hike then are very marginal. If the Fed's announcement on monetary policy firms up the October odds, I expect the U.S. dollar to record large and sustainable gains (all else being equal of course). An announcement that implies a December hike or that the Fed remains extremely tentative about hiking rates, could generate minimal reaction. At worst, I expect the dollar to hold its low from May. I also think going forward that traders should prepare for rangebound, whiplash-like trading until we get past the obsession with the first Fed rate hike. Overall, the dollar index remains supported by "policy divergence" and the extreme reluctance of major central banks to see their currencies materially gain on the U.S. dollar at this juncture.
Right now, The Japanese yen (NYSEARCA:FXY) remains my favorite currency for betting on strength in the U.S. dollar. The euro comes in a very tentative second. I am sticking by my longer-term bet on the Canadian dollar (NYSEARCA:FXC) particularly given Canada is a prime beneficiary of stronger U.S. economic performance.
Be careful out there!
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: In forex, I am long and short against the U.S. dollar using various currencies.