That’s why the Fed may not hike rate in September - September 13, 2015

That’s why the Fed may not hike rate in September

The Fed meets Sept. 16-17 and many are expecting the first interest rate hike in nine years. But there are some reasons the FOMC is likely to delay the hike. Here's why.

  • The unemployment rate is fairly low, there is no sign of wage inflation, although average hourly earnings rose by a 5-month high of 0.3% m/m in August but they remain far below their 2007 highs. The labour force participation remains low too.
  • The Bloomberg Commodity Index is at the lowest level since 2002 and downward pressure on energy prices will further drive inflation below the Fed's goal even if we expect some reversal in 2016.
  • The trade-weighted US dollar index has rallied to the highest levels in over a decade. This puts pressure on US manufacturing sector and also hurts the revenues of the multinational companies. A rate hike would put further pressure on them.
  • The Fed is also focusing on financial system stability. There was a necessary correction on the global markets in August but a tightening of financial market conditions becomes an actual problem on the high-yield debt market globally.
  • According to the IMF, slower growth in China and rising market volatility have boosted the risks to the global economy. Also, the ECB downgraded its inflation and GDP growth forecast.

Putting together the facts and the rising risk premia and volatility on the financial markets, the Fed maybe chooses the wait-and-see mode. As it stands, markets believe there is no more than a 30-35% chance the Fed will hike rate in September. This counts as a low market expectation and ought to rise above 50-60% if the Fed wants to ensure credibility.

If Fed waits too long, then the inflation may be picking up and Fed has to accommodate. But if the Fed raises too soon, there is a possibility of facing deflation as it is happening in Europe and the Fed does not have the tools to fight it.

So that’s why we think that the Fed will not raise rates in September and the first hike may come in December or even in the first quarter of 2016. If the FOMC raises rates now, this would only be a small step and that would be followed by some pause.

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