Making sense of the Fed’s thinking

The fact that Asian markets were higher today is not indicative of improving risk appetite. On the contrary, the no-change decision by the Fed would perpetuate uncertainty for longer. Naturally, the question of ‘when will the Fed raise rates if not now’, arises.

Wall Street
Source: Bloomberg

While the dovish stance adopted by the US central bank is seen as supportive for global equities, the flip side is that the Fed is not confident enough of the US economic outlook to raise interest rates. This is probably what is worrying the markets.

Fed’s Janet Yellen is keeping the doors open for a rate hike in October, noting that it is still a ‘live’ meeting. However, it is difficult to see that happening, as there will be insufficient data to materially change the prevailing view from the Fed officials. Yellen also acknowledged as such, saying that it was only a ‘possibility’.

This is reminiscent of the QE taper debate in 2013, where several Fed officials noted that the October 2013 meeting is a ‘live’ one, after deciding to hold back on scaling back its QE3 programme in September 2013. The Committee eventually announced the QE tapering in the December 2013 meeting, which was effective from January 2014.

Based on the policy statement, the economic, and the interest rate projections, if the Fed is to hike rate this year, December will be the most likely date. Market is pricing in a 44.2% probability for a December rate increase, which is still far below the more than 70% seen in the 1999 and 2004 rate hike decisions.

I feel the failure to tighten policy, even a token +12.5bps adjustment, by the end of the year will see the Fed run the risk of damaging their credibility. Clearly, a significant improvement in the US macro data, especially on inflation, will boost confidence of a rate hike.

 

China

Although Chinese equity markets managed to close up today, they were down on the week. The Shanghai Composite dropped 3.2% this week, while the CSI 300 tumbled 7%. On Friday, property counters helped boost buying, after data showed that home prices in August rose in half of the 70 cities, signalling improvement in China’s property sector.

Bear in mind that if we see stabilisation in the domestic stock markets, and signs of strengthening in China’s economy, this will build the case for Fed’s first rate hike.  The FOMC statement highlighted the Fed’s concerns about recent global developments, saying that it is ‘monitoring developments abroad’, which many feel is a euphemism for China.

 

Next week

While I expect the markets to continue digesting the impact of the unchanged rate, there will be focus on other macro events. Since China has become quite a buzzword for the Fed, Chinese manufacturing data on Wednesday, 23 September, will be of interest. The median estimate is at 47.6, although the range is between 47.3 and 49.6, which also means that most economists expect some improvement from the August reading.

In Japan, inflation data will be on the tap next Friday, 25 September, and would have implications for the BOJ. The longer-term question will be when would inflation reach BOJ’s 2% target. For now, Governor Kuroda is still optimistic that inflation would hit its goal in about a year from now. In contrast, Bloomberg survey estimated headline CPI to reach at most 1.2% by end of next year. Should inflation continue to undershoot BOJ’s target, would the Bank be forced to ease further?

We will also see a litany of Fed-speak next week, which may see more explaining after the latest FOMC meeting. I expect nothing significant or new to emerge from these speeches, but markets will still be keen to scrutinise (and speculate) the content. Littered throughout the Fed talkfest are data on housing and capital investments. One key data to watch will be the headline durable goods orders. A third estimate of the US Q2 GDP is expected to be released next Friday.

In Europe, a triple bunch of data/event risks may capture market participants’ attention. Greece will hold its election on Sunday, 20 September, the third vote this year (after January’s general election and July’s referendum). The results should be made known, heading into Monday. ECB President Mario Draghi’s quarterly testimony will be on 23 September in Brussels. European PMI is also due on the same day.

The coming week promises to be an interesting one, jammed pack with macro data and market events. Traders may also have digested the Fed’s view and formed their own views for market direction.

 

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