16th September 2015
Larry Hatheway, group chief economist, GAM, says we shouldn’t expect the Fed to underpin a genuine market reversal this month…
Markets currently think there is around a one in three chance that the Fed will hike rates this week. That is down from just over a one in two probability at the beginning of August. Clearly, the China slowdown and resulting market tumult has led the majority of investors to conclude that the Fed will not raise rates this month.
I agree that the Fed is likely to leave rates on hold this week, but also feel the decision is more finely balanced than the market consensus believes. It is clear from remarks made by Yellen, Fischer and Dudley that the top Fed decision makers believe macroeconomic and financial conditions warrant a move before long.
It is by no means clear that the Fed’s senior policy makers have concluded that the disruptive events from China and in markets will lead to a material weakening of US growth. They are unlikely to be particularly confident either way, but there is little recent hard economic data (as opposed to sentiment indicators) to suggest that the US economy is slowing. The incoming data are mixed, but overall consistent with moderate growth and, importantly, continued above-trend growth of employment.
If the Fed decides to keep policy unchanged, it is more likely that below-target and non-accelerating inflation (in both prices and wages) will be the decisive factor.
We are unlikely to get sustained market relief from an unchanged Fed position. Firstly, global growth and profits concerns emanating from China are largely independent of events in Washington. Second, even a Fed that opts to keep policy on hold is likely to remind markets that rate hikes are data-dependent and not far away – keeping open the option of a move in October. It won’t take long for markets to shift attention to the 27-28 October FOMC meeting.
As a result, neither risk assets nor the long end of the curve are likely to sustain any gains that may materialise immediately following a Fed decision to keep rates on hold. In short, don’t count on the Fed to underpin a genuine market reversal in the second half of September.