- Any decision to tighten has ramifications beyond the US - notably in China
- Much depends on the ability to balance low inflation and low unemployment
- It looks increasingly likely that September will see rates held in place
By Stephen Pope
Last week at the G20 meeting in Ankara, Turkey, International Monetary Fund managing director Christine Lagarde called on the US Federal Reserve
(Fed) to delay raising the Federal Funds rate from the record low of 0.00% to 0.25%.
Even though a key theme to emerge from the G20 was that zero bound rates could not persist forever, it was felt that the start of introducing rate increases did not have to begin straight away.
Over the past few days Lagarde has found that her call has been joined by none other than the World Bank as well as two highly influential economists: Larry Summers and Paul Krugman.
They have added their weight to the “do not raise rates club”. However, is their message out of line with the market?
The Treasury Bill structure from the one month to six month sends an interesting message
There may be a mixed signal in the market place as the US Treasury 2 year, which is highly rate sensitive, did move higher to 0.777% on Wednesday. That said, it looks as if the influence of the World Bank and the two renowned economists has had an effect as the yield has ticked lower to 0.737% ie it has lost basis points as of 1151 EST (1500 GMT) on September 10.
Market sentiment swings on daily data
The positive reading on job openings added muscle to the hawks’ argument for a September move as employers advertised at a record high rate for new positions in July (5.8 million), according to the US Labor Department.
Still, such domestic optimism that has come from a range of indicators for the month of August has to be tempered by persistent doubts about the global economy, largely due to concerns over China’s faltering growth.
Janet Yellen's decision is not actually as black or white as hike or don’t hike. Photo: Flickr
Nonetheless, the recent move higher in the Treasury 2 year and the lack of a fulsome retracement indicates just how divided the market really is over the timing of the next Fed move.
Whether or not the recent push higher can endure will depend on the confidence that permeates the market over the Fed’s willingness to squeeze policy next week.
Recent communications from the Fed reveal that when the Federal Open Market Committee (FOMC) last met it judged if that conditions for an imminent hike in short-term interest rates had not yet been achieved.
The Fed reiterated that it needed to see further improvements in the employment market and signals that long-term inflation had moved gradually toward its target of 2% before it decided to hike interest rates.
Inflationary pressure is muted as CPI is just 0.2% and this low level could appease dovish sentiments at the Fed for a delayed rate hike. Long-term inflation has failed to reach the Fed's annual 2% target for every month over the last three years.
The questions over the trimming of the next move in US monetary policy can be seen to be weighing on Fed officials. Jon Hilsenrath wrote in The Wall Street Journal that Fed officials are not near an agreement over when to begin raising short-term interest rates as they head into a crucial week of economic discussions before the September 16th -17th policy meeting
Radio silence in the divided house
September 9 marked the beginning of the Fed’s self-imposed blackout which is when the officials cease providing any commentary with the media ahead of a policy meeting and begin a week of internal deliberations and staff briefings.
Some FOMC members want to start raising the Fed Funds Rate from near zero because the job market is improving at a rapid pace and reducing economic slack. In August, the unemployment rate fell to 5.1% from 5.3% in July, which prompted Cleveland Fed president Loretta Mester to say: “We’re either at or near full employment.”
Some officials in the hawk camp also worry that if the Fed keeps rates low for too long it will fuel asset bubbles that when punctured will harm the economy in the longer-term as it has become too reliant on low costs of capital.
They are opposed though by doves that point to the low level of inflation, the USD's rise, China’s economic slowdown and recent financial-market turbulence. Their contention is that the Fed could hold rates steady for now, until they’re sure the global economy isn’t headed for broader trouble.
San Francisco Fed president John Williams said he would be prepared to raise rates this year if concerns about those risks recede.
To hike, or not to hike…is that the question?
That heading is not written in error for whilst Fed chair Janet Yellen has to weigh all the options carefully, it is possible that she could adopt a tenor of language when announcing her decision.
Janet Yellen hasn’t spoken publicly since her July testimony to Congress, when she signalled rate increases this year are likely. Her decision is not actually as black or white as hike or don’t hike.
The team of staff economists could pave the way for a new, more vocal level of forward guidance that would send a stronger signal as to the Fed’s intent over rates when the FOMC is more comfortable in a broader sense with US and global macro data points.
I have always said she should go in September, however, the weight of informed and influential opinion is mounting against such a move, so I now have to rethink and suggest she will delay lift-off until the year end.
-- Edited by Adam Courtenay
Stephen Pope is managing partner at Spotlight Ideas. Follow Stephen or post your comment below to engage with Saxo Bank's social trading platform.