What to make of the FOMC minutes?

Yesterday, news from the Federal Reserve's Open Market Committee (FOMC) surprised markets. The April meeting minutes showed the FOMC is much more open to a June rate hike than markets had priced in.

Where does it leave us in terms of our investment positioning?

Market reaction

Just two days ago, markets were pricing a 4% probability for the next hike to happen in June. They are now standing at 32%. The US dollar rebounded strongly against most currencies. At 1.1216, it's at its highest level against EUR for the month. US government bonds were hit too. US 2- Year Treasury yields hit their highest level since March. Finally, Asian equities lost ground, on fears that investors would pull back and flow into US markets. Asian currencies also retreated.

What to make of the minutes

Some market analysts argue that the FOMC is attempting to rebalance expectations, which had become out of line with Fed thinking – often a recipe for volatility.   

In fact, the FOMC has been and remains data dependent - it has now clearly reminded markets that if conditions are in place, a rate hike at the June meeting is on the table. In an environment where some participants were increasingly hawkish, that's probably a healthy thing to do. 

However, the minutes also revealed that a June hike would require continued strength in the labor market and progress towards the 2% inflation target. It's debatable whether data will provide sufficiently clear signals by mid-June for that.

So where does it leave us on our investment calls

Our investment positioning is built on the assumption that there will be 2 hikes in 2016.

The latest FOMC minutes now reinforce this assumption. It also support our US dollar overweight position against the Australian Dollar. In addition, the minutes raise questions on emerging market assets, which remain vulnerable to Fed tightening. We reflect this in a neutral Emerging Market equity position. Finally, rising rates pose a threat to US government bonds, currently our largest underweight position.

For additional details, take a look at USD: A June rate hike is back on the table (18 May 2016) and my latest Monthly Investment Letter.

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