Investment Clock insights

Economic Times November 2015

Ian Kernohan

30 October 2015

Until the September payroll print, the consensus held that while the US domestic economic situation was strong enough to justify a hike in US interest rates before the year end, concerns about the global economy would stay the Federal Reserve’s (Fed’s) hand. Then came signs that the US domestic economy was itself slowing. The monthly labour market report is perhaps the most important data input to Fed deliberations, and the September report gave some cause for concern.  The pace of employment growth slowed materially during the third quarter, while wage pressures remained remarkably subdued for this stage of an economic cycle.  The manufacturing sector also remains in poor shape, impacted by weakness in Emerging Market economies, a stronger dollar and the decline in shale oil activity.

Since the last meeting in September, some Federal Open Market Committee (FOMC) members appear to have cooled on the idea of a 2015 hike, however the latest FOMC statement keeps that option very much on the table.  In itself, this is no surprise, since the Fed want to retain flexibility.  The tone of statement was perhaps a little more hawkish than expected however, in particular the specific reference to the “next meeting”.

“In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress--both realised and expected--toward its objectives of maximum employment and two percent inflation.”

A December hike now depends on run of US data and whether market volatility spikes again (perhaps on fears of a Fed policy error).  Initial market reaction to the more hawkish than expected statement was bullish (the S&P rose), in the same way as a more dovish statement in September was taken badly and a sign of Fed concern about the economic outlook.  The Fed will be pleased to have shifted market expectations to 50/50 on December, as this allows them to keep the debate open: they cannot/would not hike, if markets were not expecting a move. 

So we’re back to where we started, each meeting is “live” but remains data dependent.   Markets will want to see a run of strong domestic data in the US, to be comfortable that the Fed is not making a mistake.

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