YELLEN VS. YELLEN
Ratner: Why the Fed may back down after all. Shmuel: The smart money’s on more than one hike.
The market seems to be counting on an interest rate increase from the U. S. Federal Reserve on Wednesday, but there is still some debate about whether the central bank might hold off again after a wait that’s already exceeded nine years.
Plenty of signs h av e emerged in recent weeks that Federal Open Market Committee members are preparing investors for a 25- basispoint rate hike. That has pushed the Fed Fund’s Implied Probability indicator to 78 per cent.
However, as Michael Hewson, chief market analyst at CMC Markets pointed out, there is at least one factor that may make the Fed think twice about a hike or could cause division among those on the rate-setting committee.
“This split could well come about as a result of the continued turmoil in commodity markets as crude oil prices, as well as metals prices, flirt with multi-year lows,” he said.
Fed Chair Janet Yellen hinted at the possibility of such a split a couple of weeks ago when she suggested that a unanimous decision wouldn’t necessarily be needed to go ahead with a rate hike.
Several Fed policymakers haven’t been shy about voicing their concerns about the negative impact international factors could have on the U.S. economy. This is for good reason, given that the most recent ISM date suggests the U.S. manufacturing sector has dipped into a recession.
“Time will tell but two engines of growth are always better that one, and with manufacturing stalling, the question the Fed needs to ask is whether they really want to run the risk of stalling out the remaining one at a time when prices are still falling and the services sector might be on the verge of easing off its best levels,” Hewson said.
It’s worthy to note that fed funds futures were pricing in 110 bps of hikes from January 2016 to January 2018. That number has since slipped to 101 bps.
Of course, smart people sometimes do foolish things, and t hat’s exactly what Mizuho Securities USA chief economist Steven Ricchiuto thinks the Fed will be doing if it hikes on Wednesday.
He noted that much of the economic data released since the Fed’s October meeting has disappointed the so- called growth optimists.
The labour market continues to show signs of strength, but GDP, industrial production, retail sales, shipments and orders of non-defense capital goods have all fallen short of expectations.
Ricchiuto also highlighted trade data that points to weak demand both domestically and overseas, manufacturing data indicating consolidation despite aggressive auto production, a housing market that looks stuck as more people shift to renting, and disappointing company profits due to limits on pricing power.
The economist believes the strength in payroll employment is a result of the shift to contract workers, part- time workers and commission employees.
“This suggests to me there is a weak case at best for the Fed to hike rates,” Ricchiuto said, sticking with his call for a rate hike in the second quarter of 2016 at the earliest. “Keep in mind that central banks have twice surprised overly confident markets with their policy decisions in the past few weeks.”
Nonetheless, the Fed is pretty much committed to hiking. Unfortunately, it’s not coming at the best time of the year, as the pre-holiday period often sees lower liquidity levels, which could lead to heightened volatility.
Steven Englander, a currency strategist at Citigroup, also noted that the Fed must be careful not to have its rate lift-off derail activity or cause asset markets to plummet. As a result, they have to present the move as tentatively as possible, with an emphasis on the likely slowness of the hiking path afterwards.
“This works both to get the doves on board ( or almost all the doves) in fulfillment of Fed Chair Yellen’s view that at turning points the Fed should speak with virtual unanimity,” Englander said. “It also works to reduce the risk that lift- off blows up in their faces, so even hawks see a reason to curb their hawkishness for a bit and wait for 2016 to press the case for a faster pace.”