Markets interpreted the minutes from the July Federal Reserve meeting as reducing the risk of a September interest rate “lift off” – but to my mind that just seemed wishful thinking. I still think September is a good bet. Worryingly markets don’t yet seem to have priced in this risk – the sell-off in recent days appears to reflect concerns over China and oil prices.
Indeed, the futures market reacted to the Fed minutes by lowering the odds of a September move from around 50% to 33%. Yet according to a CNBC survey – following the minutes – 11 of 17 economist still thought a September move was on the cards.
While markets are more often get it right than economists, this time around I favour the consensus opinion of my US counterparts.
After all, the minutes were never likely to be the vehicle through which the Fed telegraphed its intentions to move – the time gap is just too large. In fact, it’s probably fair to say that at the time of the July meeting, most Fed members has still not made up their mind about September – so expecting them to telegraph an interest rate move two months ahead of time is just asking too much.
What we do know, however, is that since the July meeting, US economic data has remained broadly firm. US payrolls rose by a further 215,000 in July, and the unemployment rate held at a relatively low 5.3%. And US housing indicators are turning up nicely. Indeed, this month the National Association of Home Builders (HAHB) confidence index rose to its highest level since November 2005. Buoyed by job gains and rising share market wealth, consumer spending is also perky.
Let’s also remember that US official interest rates remains at the “emergency” level of effectively zero – and have been for almost 7 years. And that’s despite the fact that some Fed voting members suggest the labour market is already close to fully employment.
Of course, US inflation is low – with annual core consumer price inflation around 1.4%. But core US inflation has average only 1.7% since the late 1990s, and has only rarely been above the Fed’s newly imposed 2% “target level” over this period. The US dollar is also rising – but in real terms it still remains far from high. And in a world where most other economies are not as solid as the United States, it hard for the Fed to expect that the greenback not rise further.
I think the Fed will be frustrated in its desire to get inflation anywhere near 2% – due to both a rising US dollar, falling oil prices, and intense global competition. That said, that should not stop the Fed from starting the process of ‘re-normalising’ interest rates – lest it further contribute to the risk of financial instability down the track, in particular via overly inflating equity and bond prices.
For what it’s worth, former PIMCO bond market Bill Gross is also betting on a September rate hike.
If I’m right, and the Fed chairperson Janet Yellen does eventually decide she should pull the trigger next month, I don’t expect the markets to be surprised on the day. Instead, in classic Fed fashion, the likely move will be well telegraphed through a media at least a week ahead of time.
That’s still a few weeks away – the next Fed meeting is set for September 16-17. Don’t say you weren’t warned.
How will market react? My own historical analysis suggest Wall Street usually sell off for at least the first few months following the start of a Fed tightening cycle. But provided the interest rates move are gradual and well telegraphed – as unlike in 1994 – equity prices could still end up being higher 6 and 12 months from now.
