Market was caught off guard by hawkish FOMC minutes

Market was caught off guard by hawkish minutes from the 27 April FOMC meeting and is all of a sudden reassessing its views on US monetary policy.

Following the release of the minutes, as the committee expressed support for a possible (data dependent) hike in June, the market implied-odds of a June hike jumped from roughly 15% to 35%; the odds stood at just 7.4% two-days ago before a number of hawkish Fed speakers.

This doesn't change the call for a September hike, but steers the market away—at least for now—from overly dovish US rate expectations that have largely dominated over other themes this year. This also means that the great support that EM assets have received since after the January selloff—which may not be entirely due to, but definitely is rooted in such implied odds—may start to falter, in the same way as oil prices are immediately feeling the heat of a stronger dollar.

European currency markets are trailing behind with the high yielders (TRY, ZAR and RUB) skewed towards weakness vs the CEE currencies flat or slightly positive. It’s still too early to say which direction may prevail, but we suspect that correlations with equities will continue to hold, and stock markets are currently in the red. So if the equity slump advances, there will be little in the way of further EM FX corrections. This is in line with our medium term view, but doesn’t reconcile with our more optimistic short-term one that is based on the assumption that the market would remain dovish on implied US rate expectations until the end of Q2.

If  wrong on this assumption, however,the majority of EM FX are recovering rapidly bridging the gap between short term and medium term forecasts; in other words, we could see  Q3/Q4 forecasts materializing a lot faster than we thought.