Fed Holds Rates

But, it may be just too premature for markets to celebrate…

Global markets heaved a sigh of relief when the Fed decided to hold rates. The decision to reduce the number of rate hikes from 4 to 2 in this calendar year has also gone down well with the markets. But scratch the surface and there may not be too much to rejoice about. There are 4 key things that global investors must be cautious about.

No mention of global situation…

 If you read the text of the press conference, the FOMC has religiously avoided mentioning the influence of “Global Factors” on its rate decision. What this means is that the US FOMC will continue to be inward looking. Their focus will be more on US inflation and employment while global turmoil will not play a big part in the rate decision. Therefore, analysts who believe that the US Fed will continue to hold rates due to the turmoil in China and Europe will need to do a rethink.

Macros are favorable…

One needs to remember that while inflation may still be way below the 2% mark, other factors are supportive. For example, retail spending and investments have been picking up. Similarly, the rate of unemployment has fallen below the 5% mark and the US economy is as close to full employment as is practically feasible. That just leaves inflation in doubtful territory. Here one need to remember that global oil prices have already ramped up from $26/bbl to $41/bbl. Estimates are already closing in on $55/bbl in the next 6 months. That could give a huge boost to inflation in the US and take it closer to the 2% mark.

Fed fears a credibility issue…

Fed has been talking about tightening rates for too long without doing anything substantial. That may not be great news for the credibility of the Fed. The pressure will be on the Fed to hike rates in June this year, which is evident from the implied probabilities. The Fed has focused on data and if the data turns positive for a rate hike, then the Fed may not hesitate to move faster than its originally guided trajectory.

Monetary divergence is here…

Those who are cheering the Fed status quo need to remember that there is already monetary divergence. With US holding rates and the ECB loosening aggressively, there is already a monetary divergence being created. That will surely add to volatility in the markets, even if the rates are not hiked. As we saw in January and February, volatility as an outcome of monetary divergence can be quite lethal for global markets. That has not gone away and will continue to deepen as the ECB sticks to its loose monetary stance. So, it may actually be premature to celebrate the Fed status quo! ©

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