The Federal Open Market Committee (FOMC) meet that ended on July 29th still leaves the big question open; will the Fed hikes in September or will they postpone the rate hike? For one, the Fed has enough time till September 16th as there are no intermediate meetings scheduled. That will give the Fed a full 7 weeks to analyze data on growth, labour, wages and inflation before arriving at a rate hike decision. However, as one breaks up the press release issued by the Federal Reserve Board after the FOMC meet, it looks quite likely that the rate hike may be put off from September to December. Let us understand why!
The key points of review
A few key points emerged from a review of the FOMC meet. The FOMC has noted that economic activity has expanded, but only moderately, since June. Similarly while the housing sector has shown smart gains, household spending is still quite moderate. However, the Fed is disappointed with the rate of business fixed investment and the rate of net exports growth. Weak exports growth has been an obvious fall-out of a strong dollar which has been strengthening against other hard currencies in anticipation of a rate hike.
What will the Fed look for before affecting a rate hike?
The three broad goals that the Fed will focus on are maximum employment, price stability and growth. While growth and employment have been moving in line with the Fed expectations, the price angle is not. The Fed would ideally like inflation to move up to 2% before readying for a rate hike. However, low prices of oil and other commodities have ensured that inflation stays much below the targeted mark.
The likelihood of a rate hike in September
There are three risks that the US Fed might estimate in hiking rates in September. It looks unlikely that prices of oil and other commodities could move up by September, ruling out any sharp increase in inflation. The Fed has also stated that the current rate of 0-0.25% Fed rate remains appropriate to maintain a balance between maximum employment and price stability. This probably indicates that unless the Fed sees a strong justification by September, it may choose not to tinker with the Fed Fund rates. And a strong justification looks quite unlikely by September.
The outlook for Fed rates and what it means
The Fed is quite clear that rate hikes will be contingent on maximum employment and inflation at 2%. While employment targets may still be achieved, inflation continues to be a worry due to cheap commodities worldwide. The major give away is the Fed statement; that even after the targets are achieved, the Fed may choose to keep rates constant to understand and evaluate whether the data points are sustainable or not. That means unless inflation shoots up sharply by September (a highly unlikely situation), a rate hike may not happen by September.
Interpreting the Fed Statement
The big question is how do markets interpret this statement? There are obviously a few macroeconomic variables that the Fed is worried about. Firstly, the strong dollar has negatively impacted exports for the US economy. The pressure on the quarterly results for tech bellwethers like Microsoft, Apple and IBM was a giveaway. Secondly, the sharp correction in Chinese markets and the economic slowdown may have the US worrying. It would not want to rush into a rate hike at a time when US corporations are already feeling the pinch of a global slowdown. Last, but not the least, a rate hike may induce flows into the US, something the economy is already able to attract due to the risk-off trades among most fund managers.
In a nutshell, the likelihood of a September rate hike looks increasingly unlikely from here-on. The global macro data is indicating a slowdown and a contrarian rate hike may pose a big risk for the US economy. September sounds a little difficult, unless of course something drastically changes course in the next 7 weeks. As for Indian markets, that gives some breathing space as they need not worry about immediate portfolio outflows.
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