ith concerns over the global economic outlook intensified by another Chinese rate cut, all eyes are on the FOMC meeting this week, where investors will be looking to see if the Fed give any clear indication of when a rate rise is likely, or whether they’re poised to keep the markets guessing…
Within this report Colin discusses:
• What to expect from the October meeting
• The last FOMC meeting and how markets reacted
• How the Fed itself has reacted since the last meeting
Although the Fed still appears to be on course toward raising interest rates this year, another budget crisis in Congress which could shut down the US government again has the potential to knock the Fed off track again.
What to expect from this week’s FOMC Decision and Statement
Because of all the political uncertainty in the US this week and next, it would be really difficult for the Fed to raise rates in this environment, so the Fed is likely to take the safer course and hold off its decision until December, hoping Congress gets their act together and the budget problems all blow over by then.
A delay also pushes the decision out past the next ECB meeting and a possible increase to their stimulus program. There is also a small chance the Bank of Canada could cut in early December after it cut its growth forecast last week. This would give any doves out there one last chance to increase stimulus before the Fed starts to take the monetary trend back the other way.
The Fed is likely to take this forced delay as an opportunity to signal the market with a proper “hawkish hold”. In the statement, it could downplay overseas risks and/or give a positive outlook of the US economy. Comments on employment and inflation could be particularly significant. Indications that it is waiting out the budget crisis would be taken in stride.
Finally, we’re likely to see the number of hawkish dissenters increase by one or two regional Presidents while the permanent governors hold the party line.
A hawkish hold for the US could be received positively by the markets boosting confidence and USD. It also could help US stocks to begin a seasonal rebound in recognition of a positive business environment. A dovish hold, however, could undermine confidence, send USD back down again and spark more worry about US business conditions and the prospects for corporate earnings.
What happened last meeting and why did the market react so badly?
Heading into its September meeting, all signs from Fed chatter had been pointing toward a “hawkish hold” that they would hold rates steady but signal an increase would be coming soon, which would give them time to let the dust settle from the August China-led bout of high market volatility.
The Fed’s attempt to do this through raising its GDP forecast and having a hawkish dissenter was undermined by one member taking a dovish stand and calling for negative interest rates.
More important than the decision was the market reaction to the news. For the last several years, stock markets have taken news pointing to a dovish Fed as a positive, keeping the easy money party going. (In fact, European traders still see the Eurozone that way, driving the Dax
higher after ECB President Draghi suggested more stimulus could be coming in December).
US traders, however, saw the delay and “dovish hold” as a negative for stocks, wondering what’s wrong with the US economy if the Fed still can’t back away from emergency measures and normalize interest rates?
Skepticism about what monetary stimulus really means about the Main Street economy hasn’t been contained to the US either. The recent round of rate cuts from the People’s Bank of China continued rallies in Europe and North America last Friday. Sober second thought over the weekend from Asia Pacific traders left Mainland China indices up only slightly when they had a chance to respond Monday while Hong Kong traded down slightly. This suggests that this was seen as a combination of a catch up move to recent economic and market activity, or a sign of deeper problems.
Economic Data since the last meeting
Since the last meeting, economic data has been mixed but overall suggests conditions remain on track for the Fed to start raising interest rates soon.
China’s economy, whilst struggling, has not had the full meltdown which had been feared in the summer, and China indices have been steadily recovering in recent weeks.
US payroll growth slowed but unemployment remains low with employment claims running well below 300K and continuing claims dropping to their lowest level in 15 years.
Commodity prices have rebounded from their summer lows easing deflation fears.
US trade and manufacturing data, however, have been soft. Much of this can be attributed to impact of the higher USD which has impacted US exports and overseas earnings. The slowdown in payroll growth suggests that while Wall Street remains divided on liftoff, Main Street appears to have factored a higher interest rate into their hiring plans.
Fedspeak since the last meeting
Fed comments on balance have reflected a central bank in damage control mode trying to signal that the last meeting was meant to be a “hawkish hold (rate hike still possible this year)” not a “dovish hold (liftoff postponed to 2016)”. This position has been reflected in comments from FOMC Chair Yellen, Vice Chair Fischer and NY Fed President Dudley, three of the more influential members of the committee.
Although only one of the regional Fed presidents openly dissented (Richmond’s Fed’s Lockhart), two others (Atlanta Fed President Lacker and SF Fed President Williams) have indicated they favour raising rates this year. Chicago Fed President Evans remains firmly in the dovish camp and could dissent to a rate hike from the dovish side.
The four alternate voters and 2016 regional voters (St. Louis’ Bullard, Cleveland’s Mester, KC’s George and Boston’s Rosengren) all have indicated they favour raising rates this year although they differ on the path from there.
Overall, it appears that FOMC members are still looking to raise rates this year with a few key signals:
- After permanent Governors Tarullo and Brainard came out with dovish statements, rhetoric from other Fed members downplaying the differences among members ramped up significantly, particularly after some of the market started to complain about mixed and confusing signals from the Fed.
- After the soft nonfarm payrolls report, the Fed had every reason to panic and unofficially put off a hike to 2016. Instead the Fed has been downplaying it. After the market ignored comments from the hawks discounting the number, Boston Fed Rosengren, the most dovish of the 2016 rotating regional voters came out and said payroll growth could slow as the economy nears full employment, which more people appear to have listened to.
- St. Louis Fed President Bullard called out commentators looking for lower rates, naming CNBC’s Jim Cramer in particular, calling it “unsavory”. This can be seen as a signal from the Fed rate hikes are coming and giving them a chance to get with the program.
Comments/Actions from outside parties support lift-off soon
One group that appears to have gotten the message from Bullard is the IMF, who in their October economic outlook quietly dropped their call for the Fed to hold lift-off to 2016, instead asking it to take a slow pace for further increases and raised its US GDP forecast.
Anecdotal reports from a meeting of world central bankers in Peru indicated that many emerging central bankers repeated their Jackson Hole comments from last summer, telling the Fed again they are ready for lift-off and it would be better for them to get it over with so everyone can move on.
Bank of England Governor Carney recently indicated the Bank of England could start raising rates before the Fed and has done so in the past. While few seriously expect him to go first, this appears to have been a nudge to the Fed to get on with it.
Eurogroup President Dijsselbloem suggested that postponing lift-off may not be helping matters, with further delay potentially undermining confidence instead of boosting it.
The Fed could start raising interest rates this week, except…
Overall, it appears that the Fed remains on track to raise interest rates this year and that the potential negative impact from failing to raise rates could outweigh the potential positive impact of further delay.
Many FOMC members have indicated that October is a live meeting for a possible rate hike, and that a conference call could be scheduled after a rate hike announcement if needed (although former Fed Chairs like Greenspan and Volcker never bothered with one).
Instability in Congress will likely force the Fed to wait until December
The Fed’s biggest problem at the moment is that the US government is running out of money and a dysfunctional congress could cause the government to accidentally fall off a cliff.
It had initially seemed that the US would hit its debt ceiling in late November, giving the Fed room to get out ahead of that with a rate hike. Recently Treasury Secretary Lew moved up the date the US hits the wall to November 3rd, and a treasury bill auction scheduled for this week has already been delayed because of the potential the debt limit could be breached.
The Republican party has been in disarray since Speaker Boehner announced his plans to resign at the end of the month. The first choice for his replacement withdrew over concern he couldn’t manage all the different factions in the party. Republicans are trying to coalesce around Paul Ryan but it remains to be seen if this will succeed. With the presidential primaries starting in early 2016, the heat is on to get their act together but the risk a miscalculation that forces a government shutdown remains high.
There are a number of upcoming deadlines that suggest the crisis could come to a head in the coming days.
Tue Oct 27 2 year debt auction delayed
Wed Oct 28 Republicans to vote on speaker nominee
5-year debt auction still on for now
Thu Oct 29 7-year debt auction still on for now
Full house to vote on speaker nominees
Federal highway fund runs out of money
Tue Nov 3 US expected to hit its debt ceiling
Wed Dec 2 Bank of Canada meeting
Thu Dec 3 ECB meeting where further stimulus expected to be discussed
Friday Dec 11 Stopgap budget measure expires, deadline to agree on a budget to avoid a shutdown
Wed Dec 16 FOMC meeting, member projections and press conference
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