20 September 2016 by Mark Holman
Today is the start of the much awaited two day meeting of the Federal Reserve’s Open Market Committee, so what can we expect?
Markets are currently placing just a 20% chance of a rate hike tomorrow, is that fair? To us that sounds low given the speeches that we’ve listened to from various Fed officials. Both Fischer and Yellen have hinted that two rate hikes this year are still possible, and with just three meetings left this year, that puts September firmly on the table. However, if the 80% who thought there would not be a hike were polled on how close it would be, then maybe the stats would tell a fairer picture, as we think it’s going to be a close call.
What we do know is that the meeting has not taken place yet and that the regional governors will have spent the last week pouring over the data from their states. We also know very clearly that any hike will be data dependent. So that makes September a “live” meeting, at least in theory.
Whilst we think it will be a close call there are a number of factors driving both the hike vote and the wait vote.
In favour of a hike we have a Fed that clearly wants to normalise, albeit slowly and to a new norm, depending on which governor you listen too. We also recognise that the Fed probably held back in June due to the proximity of the UK referendum on EU membership, then held fire in July due to the result and the subsequent BoE action. Back then the data was a bit stronger but the window to hike slammed shut on them. Finding the right moment has been extremely difficult for the Fed as they are very much aware of what their decision could mean for markets and confidence, and therefore ultimately the real economy.
This brings us to probably the strongest argument in favour of waiting, which is that markets are not expecting a hike tomorrow and Mrs Yellen will want to avoid another “taper tantrum”. Interestingly enough, the market conditions and breakdown in standard correlations in the last two weeks, remind us very clearly of the conditions back in May/June 2013, although to a far lesser scale. The Fed will be aware of this.
Another reason to wait is that the data that they are so ‘dependent’ on, has been unambiguously weaker, although not drastically so.
However, we save our strongest argument until last as to why the Fed should wait. This is the fact that we have already had a rate hike over the summer. This rate hike though, is not Fed induced, it comes via the banking system where $ libor has spiked higher due to a change in the structure of US money market funds. That spike in 3 month libor is coincidentally almost exactly 25bp. This is a technicality (which we will comment on tomorrow), but a real one and one which we are not certain how long it will remain in place for. The Fed will certainly be looking at this and would have to take this into account when making their decision.
So in summarising our view, we think the decision will be tight tomorrow, but on balance the Fed will remain on hold. Even if there was a bias to tighten, we think the Chair would encourage the Committee to guide strongly towards December rather than pull the trigger now and risk destabilising markets.
Alongside this though, we will be closely watching the Fed’s dot plots which we think are still considerably too high. If the debate on the new neutral rate of interest intensifies, we could see these forward projections drop materially over the coming meetings.
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