(The following Central Bank Preview was published on Alliance New Professional on Wednesday, September 16. It is an example of in-depth analysis of economic events by Alliance News journalists.)
LONDON (Alliance News) – The Federal Open Market Committee holds one of the most eagerly anticipated policy-setting meetings in recent years starting Wednesday, amid continued debate among market participants over whether the Federal Reserve will start to raise US interest rates for the first time in more than nine years.
Market expectations for a tightening of monetary policy by the US central bank have been building for months, with economic data from the world’s largest economy, particularly the labour market, demonstrating the progress the nation is making in recovering from the 2008 financial crisis. However, concerns about the health of the global economy and sluggish domestic inflation have seen some market participants peg back their calls for a September rate hike.
The base rate in the US has been 0.25% since December 2008 and the Fed has not raised rates since June 2006, prior to the financial crisis.
Salman Ahmed, chief strategist at Lombard Odier Investment Managers, the asset management arm of Swiss private bank Lombard Odier, said that the case for the Fed tightening monetary policy in September has diminished.
“Both market pricing and survey data show a clear-cut shift away from September’s lift-off date in recent weeks, on the back of the very sharp China-induced hit to global confidence in mid-August,” Ahmed wrote.
He added that survey-based expectations and market pricing put the chances of a September hike well below 50%, compared to around 80% and 60%, respectively, in July. Ahmed said he agrees with the “evolving consensus” that the Fed is more likely to hike in December than now.
Signals from the Fed Chair Janet Yellen and other members of the FOMC have been supportive of a move towards tightening policy. Yellen has repeatedly hinted that the US central bank will raise interest rates later this year and that the decision will be data-dependent.
In the minutes of the July FOMC meeting, the Fed said that it “anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the US labor market and is reasonably confident that inflation will move back to its 2% objective over the medium term”.
This statement placed even greater importance on the US jobs reports for July and August, with investors and analysts trying to quantify what was meant by “some” improvement in the labour market.
For July, the US Labor Department said job growth in the US slowed for the second consecutive month but still showed a notable increase in employment. It said nonfarm payroll employment rose by 215,000 jobs in July following an upwardly revised increase of 231,000 jobs in June and a jump of 260,000 jobs in May. Consensus estimates compiled by FXStreet.com had predicted jobs would rise by 222,000 in July, compared to the original 223,000 growth seen in June.
While the job growth came in below the consensus estimate, many market participants seemed to believe it was enough to show “some” improvement in the US labour market and sent the dollar higher against other major currencies.
In the August report, the July nonfarms figure was upwardly revised to 245,000 but the growth seen in August fell well short of consensus. The Labor Department said nonfarm payroll employment climbed by 173,000 jobs in August, well below the increase of 220,000 jobs anticipated by economists.
However, aside from the nonfarm payrolls, the rest of the jobs report was upbeat. US unemployment rate edged down to 5.1% in August from 5.3% in July, while economists had expected the rate to dip to just 5.2%. The bigger-than-expected decrease pulled the US unemployment rate down to its lowest level since hitting 5.0% in April 2008, just prior to the onset of the financial crisis. Meanwhile, average hourly earnings grew 0.3% month-on-month in August, coming ahead of the 0.2% growth seen in July and expected for August.
Following that data release, the dollar strengthened, again suggesting the report supported a hawkish view on Fed policy.
In a note to clients following the August jobs report, UBS economist Maury Harris said the data underpinned the Swiss bank’s prediction of a September rate hike. Harris said that payroll gains remain healthy enough, and the unemployment rate inched below the Fed’s year-end target, keeping the central bank on track for tightening monetary policy, in his view.
“It’s still a close call – we put the odds of a September hike at 60%,” Harris added.
While job growth has been solid, other concerns have arisen since the last FOMC meeting, most notably the heavy falls for global stocks and commodity prices stemming from concerns about the health of the Chinese economy. The world’s second biggest economy has been showing continued signs of weakness, and the country’s government and central bank have continued taking measures to support it.
On August 11, China surprised the market by devaluing the yuan, saying the official fixing rate has deviated from the market-determined rate by a large margin for a long time, and this action was required to close the gap. It noted that market expectations that the Fed would tighten policy had led to an appreciation in the dollar, to which the yuan is pegged. The People’s Bank of China went on to devalue the yuan for the following two days, sparking concerns of a currency war.
Oliver Wallin, investment director at Octopus Investments said that concerns about China, low inflation and the strength of the dollar have meant consensus expectations for a September rate hike have been diminishing to the point that a rate rise is no longer expected. Wallin said that while the Fed is required to focus on the domestic situation, the global nature of US firms and the wider impact of a US rate hike means the central bank must take international events into consideration.
Wallin added that if the Fed were to raise rates, the stronger dollar that would result would hurt US companies, which translate revenue from foreign currencies to dollars. However, the market needs to get used to an environment of rising rates and it should be taken as a sign of economic strength, he said.
Other analysts pointed to the lack of inflation seen in the US as a reason why the Fed should delay a rate hike. The consumer price index for June showed just marginal year-on-year growth of 0.1%, while in July CPI grew 0.2%. However, the continued lack of inflation pressure could be partially attributed to the fall in oil prices.
The US CPI report for August is due at 1430 BST Wednesday.
In addition, Fed Vice Chairman Stanley Fischer said at the Jackson Hole Conference at the end of August that the Fed should not wait until inflation reaches its 2% goal to begin increasing rates. He said there were good indications that inflation would rise.
Bank of America Merrill Lynch US economist Emanuella Enenajor said the probability of a rate hike is finely balanced, but she is leaning towards a hike in the upcoming meeting.
“We’ve been in the September camp for some time, and economic data have been very supportive of that. The labour market has tightened and while inflation remains subdued, with falling unemployment, inflationary pressure could build over time,” she said.
Enenajor added that if the Fed were to abstain from hiking rates in September, it probably would be a tactical delay, with policymakers guiding to a rate hike later in the year.
The Fed will announce its decision on Thursday at 1900 BST, followed by the monetary policy statement and press conference at 1930 BST.
By Neil Thakrar; neilthakrar@alliancenews.com; @NeilThakrar1
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