Sunday 17 December 2017

Daily Market Update: Global conditions for a rate hike are still not alright said Fed

Richard Ramsey

Last night all eyes and ears were fixed on the Federal Reserve’s Janet Yellen as markets braced themselves for the first rate hike in almost a decade. The rate decision was broadly seen by economists as something of a coin toss.

Once again the Fed’s policy-setting committee chose to keep interest rates on hold. Prior to the recent Chinese induced financial market volatility the expectation had been that the FOMC would raise rates at last night’s meeting. However, beyond the roller-coaster ride in equity markets last month, there has been a steady stream of evidence signalling that a global economic slowdown is in train. It is worth remembering that global trade is expanding at its slowest rate since 2009. Meanwhile Canada, Brazil and Russia are already in recession.

Last night’s dovish statement provided a reminder that the US economy is not decoupled from adverse economic developments elsewhere. Indeed, Fed Chair Janet Yellen said in last night’s press conference that developments in a tightly linked global economy had in effect forced the central bank’s hand. “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”. The statement noted that since the FOMC’s last meeting in July “economic activity is expanding at a moderate pace. Household spending and business fixed investment have been increasing moderately, and the housing sector has improved further; however, net exports have been soft”.

The latest decision to keep rates on hold featured the first dissent this year with Richmond Fed President Jeffrey Lacker voting for a rate hike. Meanwhile, the latest FOMC projections for interest rates (the so called “dot plots”) were lowered again triggering significant price action. The Fed now doesn’t expect to hit its 2% inflation goal until 2018. Three officials expect the Fed to hold fire until 2016 with one predicting no move until 2017. Janet Yellen went out of her way to keep the prospect of a rate rise this year on the table. However, traders in the federal funds futures market marked down the chances of a December rate rise to below 50% following last night’s decision and accompanying forecasts. This compares with a 64% probability of a hike in December yesterday. Markets are now beginning to doubt whether the Fed will move in 2015 at all. This will have implications for other central banks which will likely push out interest rate hikes too.

Wall Street initially greeted the news that interest rates would be kept on hold positively. However, risk appetite quickly waned with the S&P 500 and Dow Jones indices closing in negative territory. This is due to fears that global risks are mounting and this negative outweighs the benefit of continued record low interest rates. Asian and European markets have continued this theme. Overnight the Nikkei 225 index closed 2% lower. A strengthening of the Japanese currency against the dollar does not help Japanese exporters. The Euro Stoxx equity exchange is down over 1% in early trading. The failure to raise interest rates, and more importantly the dovish statement / press conference alongside a lowering of the interest rate profile, have hit the dollar on the currency markets. EUR/USD has increased by over 1% over the last 24 hours. The currency pair has jumped from $1.129 to $1.144 over this timeframe. Sterling has pushed one cent higher against the dollar over the same time period and is currently changing hands at $1.561. EURGBP has moved from 72.8p to 73.3p over the last 24 hours. In the near-term we favour dollar weakness. However, a global slowdown will impact on other economies and their central banks will respond accordingly.

For example, further quantitative easing by the ECB will hit the euro in due course. hit Yesterday’s US economic data releases provided a further reminder that the world’s largest economy is exposed to a weakening in global demand. The influential Philly Fed survey, which measures manufacturing activity in one of the US industrial heartlands (Philadelphia) disappointed market expectations and posted its weakest reading in September since February 2013. This highlights that the manufacturing slowdown that was evident in a variety of surveys last month is continuing in September. There is a lack of top tier economic data on today’s schedule. Instead the focus will be on the financial market price action as markets continue to digest last night’s Fed news.

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