Second Fed rate hike delay this year slowly getting more official

August 27, 2015

RTX1GYLG.jpgFinancial markets have all but shut the door to a Federal Reserve rate hike in September, following a rout in stocks, currencies and commodities this past week, but economy watchers are only now warming up to the idea — in public at least.

UniCredit And Credit Agricole on Thursday became the latest major forecasters to change their September call, following Barclays’ move earlier this week to delay predictions for the first U.S. rate hike in nearly a decade by six months to March 2016.

By all accounts, the slow-but-steady trickle of forecast revisions is set to repeat what happened earlier this year when the consensus for a hike in the Fed Funds Target Rate in Reuters polls shifted to September from June.

At that time, it was triggered by a surprise contraction in the U.S. economy in the first quarter, while now, it’s the slump in global financial markets, led by fears China’s economy is fast losing steam.

And one other very clear hint from a permanent voter on the Federal Open Market Committee. William Dudley, New York Fed President, effectively ruled out a September rate hike on Wednesday by saying:

From my perspective, at this moment, the decision to begin the normalization process at the September FOMC meeting seems less compelling to me than it was a few weeks ago.

But an initial rate hike “could become more compelling by the time of the meeting as we get additional information on how the U.S. economy is performing and (on) international financial market developments, all of which are important to shaping the U.S. economic outlook.

UniCredit, now expecting a December lift-off, wrote:

We are pushing back our forecast for the first rate hike from September to December. Having been in the “June camp” for a long time, we have to revise our fed funds target rate call for the second time this year.

After it was the impact of the adverse weather – coupled with uncertainty over the impacts of the stronger USD and low oil prices – that caused the delay from June to September, it is now concerns about China and the related financial market turmoil.

Only one week ago, before these concerns escalated, a September rate hike still looked like a done deal.

The change in tone from UniCredit, one of the more bullish banks on the prospects of the U.S. economy, is telling because it raises the chance of banks who already were less optimistic to revise their official call as well.

On Dudley’s candid remarks, UniCredit has this to day:

You are probably not getting it any clearer from a central banker than that.

Credit Agricole, now predicting a hike in October, wrote:

Many would argue that December might be a safer Fed call. A December lift-off is clearly a possibility if the near-term data are not convincing. However, the implementation of the first rate hike will entail a fair amount of “learning by doing” as the Federal Reserve Bank of New York desk figures out how much to drain reserves to meet the new Fed funds target.

It might be easier to accomplish this in October rather than December, which historically tends to have less liquid markets. The FOMC could set up market expectations at the September FOMC meeting for a hike later this year and re-emphasize that every FOMC policy meeting is “live”.

If the inter-meeting data met expectations, the FOMC could pull the trigger in October and use an unscheduled press conference to emphasize that the rate normalization would be quite gradual and express the Committee’s confidence that the US economic outlook was strong enough to begin to remove the exceptionally accommodative monetary policy in place.

Stocks, commodities and currencies globally swung wildly this week, rising and falling by huge amounts on successive days. That in turn has called into question the Fed’s long-telegraphed plans to raise rates.

DJI

Believers in a move next month argue the Fed is unlikely to be swayed by this market volatility and will keep its eyes firmly on the U.S. economy.

For the most part, it’s in decent shape, although manufacturing has taken a beating following the dollar’s massive rally since last summer that has made U.S. goods less attractive in global markets.

The problem is, with markets doing what they’re doing, the bar for what the Fed will consider strong enough data to hike has just been raised.

DXY

Inflation, too, is tame, at just 0.2 percent in July, and is likely to drag lower for longer owing to falling oil and commodity prices.

There is still some time before the momentous meeting next month. But if the slump in financial markets lasts, particularly in U.S. stocks, it is sure to weigh heavily on the Fed’s decision in just a few weeks.

(Additional inputs from Rahul Karunakar)

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