What will Fed do?

September focus will be on Janet Yellen

In the last Fed meet, they did nothing on interest rates and the question is what has changed in the last 2 months. Frankly, but for an additional bout of volatility in markets, nothing much has changed. US growth continues to flatter with marginal positive surprises. Inflation continues to stay low due to cheap crude and cheaper commodities. The US continues to attract capital flows from risk-off trade, which has been the investment theme over the last 2 months. So what does all this mean for the Fed decision on rates in September?

Inflation stays depressed…

To be fair, inflation is unlikely to move up sharply any time soon. With crude oil prices remaining low, the focus of oil producers is to maintain market share not to maintain market prices. That trend seems to be passing on to metals. As China is devaluing the Yuan, the focus of most metal producers is to maintain market share. In this battle for market share, prices will continue to be depressed. That means; inflation will remain way below the targeted 2% that the Fed is aiming at.

Dollar value externally…

That is a major input for the Fed while taking its rate decision. Over the last few months the dollar has been steadily weakening against the Euro and the Yen. That has given its exports some competitiveness. The devaluation of the Yuan may have changed these calculations. Since the Yuan was devalued against the dollar, a strengthening of the US dollar index can be expected. In the last quarter, pressure on tech companies was already visible due to a strong dollar. The US Fed may not be too inclined to worsen the situation with a rate hike; which will once again have the effect of strengthening the dollar.

Growth and borrowings…

These are two different parts of the Fed rate decision. Q2 GDP at a revised 3.7% is surely room for cheer. But the question is whether this growth is actually creating a heating up of the economy. The most likely answer is that it is not! For the Fed, therefore, the inflation number may take precedence over the growth figure.

Lastly, there is the issue of borrowing costs for the Fed. Typically, a rate hike tends to make borrowing easier as more lenders will flock towards higher rates. But the US hardly needs to do that. Already, the risk-off trade means that the US and Germany are getting more than their share of flows. There is no need to make rates more attractive.

What this could effectively mean is that a Fed rate hike may not happen in September. The economic compulsions just do not support it. As for December, that is still a long time away! ©

You can ask us your stock related questions with#AskReligareOnMarkets via our Twitter channel @religareonline

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