Higher rates looming

While many Fed watchers had anticipated an end this summer to the U.S. monetary policy tightening cycle, recent increases in the core consumer price index (CPI) shifted expectations in late spring.

Analysts are now talking about the potential for the U.S. funds rate to jump as high as 6 percent by 2007. Also, the Bank of England may hike rates again this year, and the European Central Bank is likely to continue nudging its rate higher.

Furthermore, the Bank of Japan could finally end its zero interest rate policy during the second half of 2006 (see “Yen still in holding pattern,” Currency Trader, May 2006). This all spells trouble for more risky emerging market assets.

“In early May when it appeared the Fed was going to go into a more aggressive tightening, it provoked a round of sell-offs in the emerging markets,” says Guillermo Estebanez, currency strategist at the Bank of America.