Source tradingview.com
Whats going on: It is a week of central bank actions after all, first by Fed FOMC meeting on Wednesday where a rate hike of 25bps is wildly expected (full priced by the market). Then by Thursday we have the Bank of England (BoE) meeting where the market seeks for further assertion of 25bps rate hike by May. The path of these two central bank policies will have wide ranging impact to the interest rates market, but also to your everyday future mortgage payments and companies that rely on debt as source of capital.
Direct Effect: Higher rates is expected and well broadcasted. Trick is what are the future expectations, will the Fed actually hike 3 times this year or 4 times? What about next year? 3 more times? It is possible for US Fed rates to increase by 1.5 to 2% in 2 years time. Is Powell going to be more hawkish and ignore the more subdued inflation rates, instead focus on other elements of the US economy? What are the dots projecting? Revisions to these dots would be interesting ( the consensus Fed board members expectation of the future interest rates).
Indirect Effect: Without going overly technical (See FT/Reuters) there is also stealth interest rate increase that will happen even if FED does NOT hike interest rates. Why? This is because FED has committed to wind down its monumental QE, starting around $20bn per month and increased by $10bn from June and again by September. That is significant reduction per month and over time will start to reduce the excess CASH in US.
What does that mean? Reduced excess cash is US centric, meaning there will be less dollars available when there will be more US debt issuance to FUND Trump tax policies. Tax cuts also encourage international US companies to bring the foreign Liquid assets (cash they can move freely) back to US. All of this would INCREASE demand for USD and may well lead to a stronger dollar vs rest of the world currency (think about it, USD has been weakening awhile). It also means more demand for USD tends to increase the Dollar funding pressure for financial institutions (higher rates to borrow USD). This means in the long run higher borrowing cost for everyday consumers as cash becomes more valued asset class.
Reference: https://www.ft.com/content/334a1266-2b54-11e8-a34a-7e7563b0b0f4
The counter effect to reduce stress of Dollar funding would be abolishing tight regulatory limit on banks balance sheet (Leverage Ratio). But that is unlikely to happen until 2019. So in the mean time we may get stronger dollar in the medium term as twin effect of hike of rates and funding pressure causes a localised effect in the US Dollar money market. EUR/USD is moving towards 1.22 coming off the 1.23 as market feels the effect of these issues.
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