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By Kathy Lien, Chief Strategist of DailyFX.com
Federal Reserve: A rate hike in the third quarter
With no economic data released today, the US dollar weakened modestly as traders toy with the idea of whether the Federal Reserve will raise interest rates in the third quarter.
Fed fund futures are currently pricing in a 92% chance of a quarter point rate hike in September.
One of the primary arguments against a third quarter rate hike is the election year.
The fear is that a rate hike could create unwanted political reverberations which could be legitimate if it wasn't for the fact that the Federal Reserve is suppose to be independent.
By law, the Fed's monetary policy decisions do not need to be ratified by the President or Congress. Therefore logistically, the Fed should not be sensitive to the political environment, let alone succumb to political pressure.
With President George W. Bush having already served two terms as President, not up for reelection, this reduces his inclination to meddle with the decisions made by the Federal Reserve.
On top of that, historical data indicates that rates have been increased during election years. Over the past four decades, there have been 10 elections not including the upcoming one.
In seven out of the past 10 elections, rates were increased at one point or another during the election year.
For example in 2004, when George W Bush was up for reelection, interest rates were 1% in January 2004 and at 2.25% by December.
In 1988 during Reagan's first election, interest rates were tightened from 14% to 20%. Based upon the past 40 years worth of data, the Federal Reserve is actually more likely to raise interest rates during an election year than to leave them unchanged.
Elections should not factor into the Federal Reserve's monetary policy decisions and if it does, there may be an even bigger problem at hand, which is the independence of the central bank.
The Fed's job is focus on economics and not politics. Meanwhile the Philadelphia Fed index and leading indicators are due for release tomorrow. The drop in the Empire State manufacturing survey skews the risk of the Philly Fed index to the downside.
Euro edges higher, SNB expected to leave interest rates unchanged
The Euro edged higher against the US dollar but the gains were limited as both the Eurozone and the US economic calendars were devoid of any market moving data.
Construction output was the only number released from the Eurozone and the decline in April was slightly less than the previous month.
ECB member Stark continued to talk about inflation risks, which may explain why the Euro has strengthened.
The Eurozone economic calendar is relatively barren tomorrow as well, which leaves the market's focus on Switzerland, who will be releasing their latest trade figures as well as making an interest rate decision.
The Swiss National Bank is largely expected to leave interest rates unchanged at a six year high of 2.75%.
However like the rest of the world, inflation has also hit Switzerland and as a result, hawkish comments or even a rate hike could come out of tomorrow's meeting.
As recently as 22 May, SNB Vice President Hildebrand said that the fastest pace of price growth in 15 years has put the central bank in an 'uncomfortable situation.' The possibility of a rate hike has driven the Swiss franc to the highest level against the Japanese Yen since February 1991.
Kathy Lien, Chief Strategist, Daily FX
