They say a week is a long time in politics and the same could be said for financial markets given that only a week ago the markets were pricing in the prospect of a September rate rise at about a 40/60 probability as US data continues to give conflicting signals as to the underlying strength of the US economy.
Events have moved on somewhat since then with last week’s sharp drop in the latest Caixin Chinese manufacturing data to a 77 month low,
prompting a global stock market rout of 2008 proportions, which saw both the FTSE
100 and S&P500 trade at levels last seen at the end of 2012, and the beginning of 2013.
Now the talk is less of when the Fed will raise rates but more of whether they should, or even whether they should implement further easing in the form of QE4, given that most of the gains seen in the wake of recent easing measures by the Bank of Japan and the European Central Bank have gone up in smoke.
Even the President of the Atlanta Fed Dennis Lockhart,
who earlier this month was saying that the bar to not acting on rates had got that little bit higher, appears to have gone a little lukewarm on the idea
in comments earlier this week.
While he stated he still expected to see a move on rates this year he was careful to not be pinned down specifically on timing, saying that the strength of the US dollar and the China slowdown were serious concerns.
The continued improvement in the US labour market certainly reinforces a narrative of an improving economy, and we have seen “some further improvement in the labour market”
if you ignore the pitifully low participation rate, but it now appears that this is likely to be less of a significant driver in the Feds deliberations between now and next month’s meeting.
Concerns about the slowdown in China are spooking global investors,
and given recent falls in global markets the wisdom of raising rates, albeit from extremely low levels does appear, under current market conditions, questionable.
We know the Fed is concerned about falling oil prices because of the removal of the reference to the stabilisation in energy prices from the recent July Fed statement.
When the Fed met in June, US oil prices had recovered to over $60 a barrel, and there had been a belief that we’d seen the lows.
Since then we’ve dropped to new six year lows below $40 a barrel
, and markets are slowly waking up to the fact that it is becoming less reasonable to assume that US policymakers will ignore the so called transitory effect of lower energy prices, when compared to June 2014, prices are down from peaks of $108 a barrel.
Not only that since June 2014 the Reuters CRB index has slid from $310 to multi year lows below $190, and the lowest levels since 2001
, a decline of over 35%.
Given the concerns expressed in the most recent minutes of the July FOMC meeting about the low rate of inflation, the strength of the US dollar and events in China, it is quite likely that these concerns are likely to be much more pronounced now,
a fact that appeared to be confirmed by New York Fed President and permanent FOMC voting member Bill Dudley on Wednesday.
His comments that the case for September was less compelling than a few weeks ago could well have been the final nail in the coffin for a move next month.
His admission that there was still “excess slack in the US labour market” didn’t sound like a man in a hurry to push rates higher, which suggests that next week’s non-farm payrolls won’t shift the dial much in terms of the wider debate about interest rate policy.
As such this week’s upcoming annual central bank symposium in Jackson Hole Wyoming may not offer up much in the way of further clues in the context of what the Federal Reserve might d
o next month, particularly given that while Fed Chief Janet Yellen won’t be in attendance.
Her deputy Stanley Fischer certainly will be there but he has already played down the prospect of an imminent rise in rates
in an interview with Bloomberg, earlier this month, so expect him to reiterate that stance even further given how events of the past week or so have unfolded.
The subject up for discussion over the next few days will be “Inflation Dynamics and Monetary Policy”
, which is rather topical given the debate currently raging about the lack of inflation globally.
Recent events do appear to be giving the Federal Reserve significant wriggle room in terms of pulling back from a rate rise next month,
particularly since it is missing its inflation target by quite some distance, and its insistence that the falls in commodity prices are transitory in nature are starting to become a little discredited.
A fourteen month slide in energy prices is anything but transitory
and recent events in China would appear to suggest that the low inflation environment could well have further to run, especially if China continues to slow and we get further policy easing.
Given the events of the past few days the narrative appears to be shifting and while a week ago all the talk was of a possible rate rise
and the timing of such a move, we’re now starting to hear calls for further easing in the form of QE4.
While markets will welcome this narrative shift, more QE is not the answer either,
but the fact that it is being aired gives an indication of how the mood has shifted.
Given current market conditions the effect of a rate rise now is likely to be highly unpredictable,
and could well signal a direction of travel, unless Fed officials pre-commit not to raise rates again for some time, which seems unlikely as no central bank likes to pre-commit to anything.
There is a growing feeling that the window for hiking rates has been and gone,
and that the Fed missed the opportunity 12 months ago when the economy was stronger than it is now.
If the Fed weren’t prepared to hike then when the economy was stronger, why on earth in the current environment take the risk now, when inflation remains benign and could well decline further, and stock markets are sliding sharply over concern about global fundamentals.
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