Financial markets have just been shaken by a major blow that has made many market players uneasy. The newly released FOMC meeting minutes earlier this morning have revealed that a large number of US policymakers are preparing to become more hawkish.
Fed Ready to Raise Interest Rates in the Third Quarter
The meeting minutes revealed a very surprising time bomb: the majority of Fed committee members agreed that a policy tightening would be most likely if inflation continues to stubbornly remain above 2%.
This was a major blow to the market because it erased the initial narrative that expected an interest rate cut. Coupled with strong pressure from many FOMC committee members to remove the ‘easing bias’ from their official statements, large institutions are now starting to reshuffle their portfolios.
Investors are starting to expect higher borrowing costs to last for a long time, which is a direct fuel for the US Dollar’s strength in the long term.
Middle East Conflict & March Inflation Hits 3.5%
The main reason why the Fed turned so aggressive is because the March inflation forecast (PCE) jumped sharply to 3.5% due to a surge in energy prices. The prolonged conflict in the Middle East has triggered supply chain disruptions, rising transportation costs, and soaring input prices.
For the market, this is a signal of an ‘adverse supply shock’ where the US economy is forced to deal with rising prices for goods even as labor growth begins to level off.
This fear poses a very high inflation risk (upside risk), forcing investors to flee markets that do not provide interest returns and rush to the US bond market that now offers yields that guarantee more profits.
Stable Labor Market, Green Light for Fed to Act Aggressively
Although employment data recorded a relatively slow average growth, Fed members assessed that the US labor market has actually reached a strong stabilization level with the unemployment rate remaining low at 4.3%.
This is a key reason why the minutes sound so dangerous, a still-resilient economy gives the Fed the green light to continue to act aggressively without worrying about drastically damaging the labor market.
While there is a minority voice worried about the risk of economic fragility, the hawkish majority voice that dominated the meeting has convinced the institution that a cash position in USD is far safer than holding non-yielding assets like gold.
Inflation Data Coming in Keeps Hot (USD Terrifying, Gold Leaking)
If the US economic data following this minutes continues to support the narrative of the FOMC minutes by showing peaking inflation, the market will price-in for an absolute Fed rate hike. The dollar will skyrocket, bond yields will soar
US Economic Data Suddenly Falls (USD Experiencing ‘Profit Taking’)
However, if the US employment (NFP) or consumer spending data coming out later this week is much worse than expected, the market will reassess the Fed’s threat. This will force investors to take profits on the USD, temporarily weaken bond yields, and give a breather to the rest of the market.
Highlight
Upcoming CPI & NFP Data Report: The market is currently very sensitive to any macro data. Investors are waiting for the latest inflation and NFP data as physical evidence, is the warning of the majority of Fed members in this meeting minutes really justified or just a financial political bluff.
This time the FOMC minutes are an official warning that the “King Dollar” is not ready to give up his throne.
