"…if the economy continues to improve as I expect, I think it will be appropriate at some point this year to take the initial step to raise the federal funds rate target and begin the process of normalizing monetary policy. To support taking this step, however, I will need to see continued improvement in labor market conditions, and I will need to be reasonably confident that inflation will move back to 2 percent over the medium term." - Janet Yellen Chair of the U.S. Federal Reserve, at the Providence Chamber of Commerce, Providence, Rhode Island on May 22, 2015 in "The Outlook for the Economy"
This quote almost four weeks ago provided the market the most direct guidance to-date that the Fed will likely hike rates this year. The U.S. dollar index (NYSEARCA:UUP) closed higher on that day. Yet, the dollar only managed two more higher closes before retreating to current levels: 1.2% lower than the post-Yellen close. The index is sitting below where it traded ahead of May 22nd's trading.
The U.S. dollar index is still trending down from recent multi-year highsSource: FreeStockCharts.com
Two weeks after Yellen's pronouncements, the U.S. reported a very strong employment number, and the odds for the first rate hike shifted from December to October. Those odds never made much more progress, and the U.S. dollar has traded lower ever since. Now, the odds have shifted right back to December for the first rate hike.
In the charts below, the x-axis shows the future month of the Fed meeting. The y-axis provides the odds of a first rate hike occurring 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 (BLUE), the previous day (red), and the day shown in the chart's title and legend (green). All dates are in 2015.
The odds for the first Fed rate hike return to DecemberSource: CME Group Fed Watch
While the odds of a rate hike in October are well above levels from a month ago, the odds no longer breach the 50% threshold in October. On Tuesday, the odds fell further for October: 44.5%, closing in on levels from a month ago. The odds for December also fell from 66.5% to 64.6%. It is easy to blame heightened fear about Greece's financing as a reason for the decline, yet, the euro (NYSEARCA:FXE) strengthened coming out of the weekend.
Given the Federal Reserve is likely trying to make the first rate hike as anti-climactic as possible, I am expecting the Fed to heed the market. If the Fed makes any references to timing for the first rate hike in Wednesday's statement on monetary policy, I fully expect them to favor language implying the end of the year. December also serves the purpose of slow rate hikes. The 2016 Presidential race will be in full gear then, and the Fed will be extra cautious about becoming a distraction during the political season. The Fed will have plenty of reason for being "one and done."
As a result, I am looking for more weakness in the U.S. dollar index in the immediate wake of the Fed release. After the dust settles, all eyes should turn to the Bank of Japan's (BoJ) decision on monetary policy on Friday. This will be the BoJ's first official opportunity to clarify its stance relative to the fresh bout of weakness in the yen since Yellen's comments in late May. The BoJ meeting could set the tone and mood for trading the U.S. dollar index for days to come thereafter.
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: I am long and short various currencies against the U.S. dollar