Will the Fed bite the bullet in December and finally hike rates? Or will the Fed prefer to wait into 2016 before taking a rate hike decision. The rate hike was first due in June 2015, but till date it has not happened. There are a variety of reasons espoused for the same. The global economy is slowing down; even the IMF has downgraded global growth by 20 basis points. China is creating a global crunch due to a fall in demand. And higher rates mean a stronger dollar. A stronger dollar is already hurting companies like Apple, Microsoft and Wal-Mart. Even as the clamour to hike rates in December is growing, the Fed will be up against a plethora of hurdles before it can actually hike rates. What exactly are these hurdles?
Fed just can’t ignore the global markets…
It is one thing to talk of central bank independence and another thing to walk the talk. Like it or not, central bank decisions cannot be divorced from markets. So Janet Yellen’s first hurdle will be global market volatility. A couple of months back, the Chinese devaluation sent tremors across global markets as it was construed as a clear signal of an impending global slowdown. Then there is the geopolitical risk in Syria where the US and Russia are almost staging a repeat of the Bay of Pigs in 1963. Any negative developments could roil markets. Yellen needs an environment where there are no potential economic or political risks that can threaten to impact markets at short notice. In such a situation, a rate hike will only exacerbate market volatility and make the rate hike decision unpopular.
Need a feel-good factor in the US economy…
Unemployment in the US is at record low and that is the least of the concerns. Of course, the Fed will be worried that a sharp fall in unemployment could trigger inflation, but that is less of a worry. Yellen will more keen to ensure that consumer spending sustains in the coming months. Americans, who were traditionally dis-savers till 2009, have turned into net savers due to low inflation and low interest rates. These savings can translate into solid consumption demand, which is a pre-requisite for a rate hike. Another missing link in the US economy is how housing picks up. Over the last 4 years, the US housing demand graph has been steadily shifting upwards and that a good sign. This shows that home sales are on an upswing and that should help Yellen in the rate decision.
US exports could be the key; they cannot afford another Wal-Mart moment…
Flat revenue guidance by Wal-Mart wiped out nearly $22 billion from its market value. What was left unsaid was that this was largely due to the impact of a strong dollar on its global revenues. The US government cannot afford more Wal-Mart moments and hence exports data over the next two months becomes critical. Remember, a rate hike will make the dollar stronger and will put US companies operating globally at a disadvantage. US companies have also been badly hit by a slowdown in global demand, especially China. In fact, if the impact on exports is likely to be too sharp, Yellen may opt to substitute the global squeeze for a rate hike and let rates remain.
What are the next in line economies doing?
Central bank policy has been synchronized since the global economic crisis of 2008. Most of the key developed economies like the US, UK, Europe and Japan have kept their rates close to zero levels. While the US may have wound up its QE program and the other developed economies still continue, that is not exactly a major bone of contention. A rate hike, however, is a different animal altogether. A rate hike by the US will lead to a shift of portfolios flows and result in a stronger dollar. If global demand and growth does not pick up then the US may look out of sync in the global economic market place. Hence Yellen will also be closely looking at the other key economies like Europe, UK, Japan, China and the rest of Asia to calibrate her thought process on rates.
A rate hike is hardly going to be an easy decision. The global markets have a created a unique situation where the US is showing signs of growth-related froth. Other economies are struggling to grow. This is unlike 1994, where the rate hike decision was much easier. Even in 2006, there was froth in global markets and a rate hike was a logical decision. Year 2015 presents a unique situation for Janet Yellen. If she hikes rates, she will have to walk it alone. Whether the Fed wants to take that risk after 9 long years, will finally determine the rate decision when the Fed meets on December 15.
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