Expectations of an imminent increase to the near-zero interest rate in the US were the key driver behind the rally in the US dollar. The greenback appreciated 11.2% against a basket of major currencies prior to the Federal Open Market Committee (FOMC) meeting in March. The dollar index rose over 100 for the first time in 12 years.
However, the rate hike decision was delayed time and again, which saw market participants trimming long USD bets. Despite this, the dollar theme remains intact, as looking from recent speeches, Federal Reserve officials appeared to have made a strong commitment to a rate hike this year, barring a severe deterioration in the US economy. The dollar index is still up by about +6% of gains at the end of September.
There are only two FOMC meetings left in the year: 28-29 October and 16-17 December. If the Fed is to raise rates this year, December is still the most likely month. Although Fed Chairperson Janet Yellen noted that October was still a ‘live’ meeting, she had downplayed the probability of a rate hike by saying it was only a ‘possibility’. In my view, it is a foregone conclusion that October will see another no-move decision, as there is insufficient economic data to justify a policy move.
According to Bloomberg, the Fed fund rate futures showed that the implied probability of an October move remained below 20%, while that for December stayed under 50%.
Looking ahead, October promises to be a very interesting month. Market participants will hang on to US macro data as well as global market developments, to assess if the view to raise rates in 2015 still has merit.
Market volatility and weak inflation hinder rate hike
Following the disappointment and trepidation of the rate inaction at the March and June FOMC meetings, there were higher hopes that September will be the month. As things stand, September was not meant to be the month either. Broadly speaking, the decision to leave rates unchanged is indicative that the global economy and the US economy are not performing as well as expected.
The September policy statement was noticeably more dovish than expected. Fed was concerned about recent global developments. The statement noted clearly that the Fed is ‘monitoring development abroad’, adding that these ‘global development may restrain activity and put further downward pressure on inflation.’
The US dollar initially depreciated after the September FOMC meeting, as the inaction prompted some traders to pare long dollar bets related to a rate hike. The markets had largely priced in the no-move result a couple of weeks before the meeting. The modest USD dip post-result confirmed the view, which helped to explain why the dollar index rebounded back to pre-FOMC levels soon after.
However, the message from the top echelon of the Fed remains the same. Since the September meeting, a number of Fed officials have stressed that they are quite happy with the improvement in the job market, and would be prepared to look past inflation data to increase rates this year. At the September meeting, 13 out of 17 Fed officials indicated their expectation for a hike to interest rates this year.
These statements however reinforced the claim that the rate hike delay was mostly driven by global market volatility. Clearly, what follow this corollary is that would external developments and market volatility concerns become impediments to the Fed raising rates. For if the US central bank holds back from raising interest rates in the coming meetings due to global financial gyrations, when would they ever pull the trigger?
Increased risks to push Fed to act
The risks of not raising rates are on the rise. First of all is the Fed’s credibility. Various Fed speakers have, on many occasions, expressed confidence that rate normalisation is on the table this year. Secondly, the longer they delay the imminent rate move, the greater the uncertainty that financial markets will face.
Varied interpretations of the Fed’s view and related worries about global growth will continue to beget a highly volatile market environment, where any unexpected negative news can lead to spectacular selling. A case in point is the Glencore’s plummet on 28-29 September, which prompted a global selloff in mining and commodity-related stocks.
Another delay in rate hike this year could potentially see an aggressive selloff in the USD, and heightened state of volatility in the financial markets. I feel the Fed is probably unwilling to take this risk, which means they are likely to raise in December, no matter what.