Fed leaves rates unchanged

It’s a case of damned if you do, damned if you don’t. The highly-anticipated FOMC meeting ended with the Committee keeping rates unchanged, with a lower rate trajectory going forward.

Front entrance at the USA Federal Reserve
Source: Bloomberg

The Federal Reserve (Fed) decided against raising interest rates because of the current market turmoil, growing global growth risks and sluggish inflationary pressure. The decision was almost unanimous with only one Fed policymaker, Richmond Fed President Jeffrey Lacker pushing for a 25bp hike.

In the policy statement, the Fed noted that ‘recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term’.

At the June meeting, the median rate expectation was 0.625% (2015), 1.625% (2016) and 2.875% (2017), according to the dot plot graph. At yesterday’s meeting, they were lowered to 0.375%, 1.375% and 2.625% respectively.  Fed chief Janet Yellen said that most Fed officials are still expecting one rate hike later this year.

Interestingly, there was one FOMC voter who thinks the US central bank should move to negative interest rates until at least the end of next year to steer the US economy towards full employment and its 2% inflation goal.

The Committee reiterated that the subsequent pace of the federal funds rate increase following the first rate hike would be slow, even as employment and inflation are moving near its target levels.

The impact of the unchanged decision is somewhat mixed. On one hand, a dovish slant in the Fed language pointed towards an extension to the support given to equity markets on the back of easy money. On the other hand, the Fed’s reluctance to raise interest rates suggested the US economy is not improving as quickly as expected, despite recent steady job gains.

Markets have been pricing in the possibility of an unchanged September rate, with the dollar index dipping to around 95.0 for most of this month. This could explain why the dollar did not fall as dramatically after the Fed decision, weakening 0.9% against a basket of major currencies. In comparison, the greenback fell 1.8% on Black Monday (24 August) where there was a global selloff in equities.

The weaker dollar saw EUR/USD push above 1.14 while USD/JPY dipped below 120 but had trimmed some of those losses in early Asia. Likewise, AUD jumped 1.5% above 0.7250 but the rally was short-lived as the currency retreated below 0.72, suggesting that Fed decision was more or less priced in.

A number of financial markets reacted quickly around the Fed decision. US treasuries reversed most of its losses in the run-up to the FOMC on Thursday. 10-year yields fell 10bp, after rising 11bps in the previous two sessions. Gold also benefitted, with spot prices climbing to $1130, the highest in two weeks.

However, oil futures slipped despite a softer US dollar. WTI remained capped below $47, but is still higher on the week, after the strong rally earlier in the week. The WTI-Brent gap has narrowed recently, as falling US crude stockpiles and production is helping to put a floor below WTI prices. On Wednesday, the EIA expects national production to fall by another 325,000 bpd in the third quarter. Output is estimated to continue dropping by a further 340,000 bpd over the next 12 months.

Asia is going to have a very cautious trading session today, as market participants are still digesting the rate decision and deciding what to make of it. The 1.5% swing in the S&P500 following the FOMC announcement suggested as much. Some focus will remain on China. The property data for August is due in the morning.

Meanwhile, the country’s securities regulator pledged to continue cleaning up illegal securities business, urging local regulators to carefully screen margin funding accounts. Outstanding margin lending in China remains on a downtrend, with the total amount falling further to CNY 935 billion as of 16 September. The rally seen in the Straits Times Index (STI) is likely to be given back today, particularly if China’s stock market headed south.


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