U.S. Interest Rate Expectations

According to the Fed Reserve Bank of Cleveland, here are the current market predictions for what the Fed will do during their August FOMC meeting:

Notice on 06/26/06, there was a 90% probability that the Fed would hike rates to 5.50% in August. Here were the exchange rates at the time for the majors:

  • EUR/USD: 1.2582
  • GBP/USD: 1.8229
  • USD/JPY: 116.31
  • USD/CHF: 1.2433

Now let’s fast forward to today. Expectations have fallen and now the market "only" sees a 45% probability that the Fed will hike rates to 5.50% in August.

Market expectations were essentially sliced in half (from 90% to 45%). Check out the current exchange rates for the majors:

  • EUR/USD: 1.2749
  • GBP/USD: 1.8629
  • USD/JPY: 114.78
  • USD/CHF: 1.2338

Here’s how the currency pairs performed in that time period:

  • EUR/USD: +167 pips
  • GBP/USD: +400 pips
  • USD/JPY:-153 pips
  • USD/CHF: -95 pips

Can you see how interest rate expectations affect currencies? Now I’m not saying that interest rate expectations is the only factor moves currencies but it is a BIGGIE and one that you should definitely be aware of.

There’s less than two weeks before the Fed meets again and the market currently believes that its a coin flip whether the Fed hikes to 5.50% or pauses and keep rates unchanged at 5.25%

If any new piece of information comes out between now and then that significantly causes this "coin flip" probability to change, we will see some huge volatility in the market. The next couple days should be exciting.

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