A long time ago in a land far far away the US Federal Reserve raised interest rates. It happened in June 2006 and was announced by a man named Ben, no, not Kenobi, but Bernanke, and there the Star Wars analogies end I’m afraid, but since then it’s been pretty much one way traffic for interest rates, which is why today could be extremely symbolic.
If the Fed does decide to raise interest rates today it will be the first G7 central bank to do so since the Great Financial Crisis of 2008, apart from the ECB and that didn’t end too well.
For the last seven years the Fed Funds rate has been set in a band of 0%-0.25%, after being slashed from 1% in December 2008. Before that the rate had been set at a similarly fixed rate and had done so at every meeting since mid-June 1989 when it had traded in a band of 1/8, fixed between 9 5/8 and 9 ½.
Given all of the noise surrounding the Fed’s intentions today it seems unlikely that any decision would be unanimous, given the sharp declines in commodity prices seen since the last Fed meeting in October, which means it could well be difficult to form a consensus amongst the various policymakers.
As things stand since the last Fed meeting alone, the Bloomberg commodity index has slumped 10%, to within an inch of its 1998 lows, while Brent oil prices have declined over 22%, and US prices have dropped over 24%, not to mention the fact that the latest US ISM manufacturing index has slipped into contraction.
Given that financial conditions are now worse than they were in September when the Fed stalled on a rate rise, the Fed is now set to hike in an environment which is less benign than it was then.
This in itself carries risks, particularly in the lead-up to Christmas where we’re likely to see liquidity start to decrease and volatility increase.
Given the Fed’s ability to surprise and the current uncertain environment does it seem likely that the Fed will do as the market expects, or could we see a seriously split vote of at least three dissenters, with Evans, Brainard and Tarullo the most likely candidates? We need to consider the divergent nature of views aired in recent weeks which are bound to come into play and there is also the remote possibility that we could see a fudge that pleases nobody, and catches the market by surprise.
A surprise could take the form of a band hike of 12.5 basis points, as opposed to 25, or the removal of the lower bound to a fixed rate of 0.25%. Moving the rate by 12.5 basis points wouldn’t be an unusual state of affairs given that this was done on a periodic basis in the 1980’s, but it would fly in the face of market expectations, and would certainly be a case of back to the future.
As things stand market expectations are for an increase of 25 basis points, with a 78% probability already priced in, and already we’ve got predictions that we could get further multiple rates rises next year, which in an election year seems barmy.
How these expectations are managed is likely to be of particular importance, more so than any actual rate move itself, if it happens.
There has been a lot of talk about a dovish hike, but that comes across as an oxymoron, which means communication is likely to be more important than ever, something the Fed has been extraordinarily bad at this year.
At any other time with the data as it is, it could be reasonably argued that the Fed would stay on hold, unfortunately times are not normal and they have boxed themselves into a corner where if they don’t hike they will look weak, and if they do hike and then have to cut again, they will lose whatever credibility they have managed to hold onto this year.
Whichever way the decision goes it is hard not to think the Fed may well be on the brink of a serious policy mistake, of the same manner of the ECB in 2008 and 2011.
Before today’s momentous Fed decision we get to digest another snap shot of the UK economy with the release of the latest unemployment and average earnings numbers for the three months to October.
Expectations are for ILOunemployment to remain steady at 5.3%, though we could see a drop to 5.2%, after the single month rate in September came in at that level in last month’s numbers.
The latest wages data is expected to see a further slowdown from 2.5% to 2.3%, still well above the latest inflation numbers but still a concern given that earlier this year we were around 3%.
In Europe, we are due to get preliminary manufacturing and services PMI data for December from Germany and France, where we will get to see how much of a slowdown the French economy has seen in the wake of the Paris terror attacks, particularly in the services sector.
EURUSD – another failure at the 100 and 200 day MA at 1.1050/60 has seen the euro slip back and could well fall back towards 1.0820. Given the recent bullish weekly reversal the upside remains the vulnerable side towards 1.1120 and 1.1200.
GBPUSD – having failed to overcome the 50 day MA the pound has slipped back quite sharply and could well slip back below the 1.5000 level. Despite this the bias remains towards further gains towards the 1.5300 area and the 200 day MA. A fall below 1.4880 would negate this prospect of a move higher and prompt the possibility of further losses.
EURGBP – having failed at the 0.7300 area which was the 61.8% retracement of the entire down move from the October peaks at 0.7495, and the November lows, we could slip back towards the 0.7200 level and 200 day MA. We need a break either way to determine the next move here but the bias could be lower.
USDJPY – the bias remains for a move lower towards 120.00 while below the 122.20 area. It would take a move back through 122.30 to delay this prospect and argue for a retest of 124.00.
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