When will US Fed stop hiking rates?

AGAINST Fed rate hikes, trade fears and concerns over slowing growth, a part of the US bond yield curve has inverted, posting a red flag for possible recession.

Recession may only happen in one to two years but markets are already sending a strong message to the Fed to stop hiking rates and possibly later, lower them to push off recession.

Past instances show that the Fed usually keeps raising rates; is it about to make the same mistake?

Fed officials have been firm about increasing rates this month, but would be flexible on rate hikes next year as the US economy, weighed down by trade tensions and debt, as well as fading stimulus from tax cuts, might be impacted.

With the latest round of market turmoil, markets are lowering the chances for a rate hike this month, and next year.

Even if the Fed raises rates for this month, markets think there may be only one more instead of three projected hikes next year.

Investors’ concern over slowing US growth as reflected in some key economic readings, the dampening effect of persistent trade tensions and the Fed’s continued rate hikes, are reflected in the caution shown on the yield curve.

US recessions had mostly started when the Fed raised rates, taking away the punchbowl when the party gets too hot.

While the current rate hikes are already working to deflate the bubbles in bitcoin, stocks and bonds, markets consider it is time for the Fed to pause its rate hikes.

In fact, some think the Fed may have overshot in its rate hikes, considering still low inflation and severe market volatility.

A softening in tone, from “long way” to neutral to “just below”, is noticeable, as Fed officials appear to be wavering on when to pause.

And that moment is crucial for emerging markets which is trying to find a firm footing.

In the meantime, markets are clamouring for a “Powell put” (the “Greenspan put” was coined after the 1987 stockmarket crash when the Fed cut rates in the midst of a tightening cycle).

“A Powell statement that further rate hikes are on hold will send markets rallying 5% to 10% higher,’’ said Pong Teng Siew, head of research, Inter-Pacific Securities. “He should be getting ready to make that statement.”

No doubt there is constant reference to the strong US labour market but there could be some loss of momentum; the four-week moving average of initial jobless claims rose 4,250 to 228,000, for the week ended Dec 1, the highest level since mid-April, said Reuters.

Jobs added in November, at 155,000, is considered still strong but was below expectations for 190,000.

Average hourly earnings rose 0.2% from October, against forecasts for 0.3%. It will be interesting to watch if indeed there will be a “Powell put.” Or will he instead put an end to the “Greenspan put” as the Fed has been criticised to be encouraging excessive risk taking?

In the face of deteriorating financial conditions, central banks may have to act fast to prevent further downside.

An inversion of a small piece of the Treasury yield curve occurred recently when for the first time since the US recession in 2008, rates on two-year notes went higher than those on five years; similarly for three and five-year notes.

The most crucial inversion will be when rates on two-year Treasuries push above those on the 10 years, as this occurrence had preceded every recession since the 1970s.

The yield on the benchmark 10-year note has been falling sharply; it fell to 2.83% last Thursday, having reversed its climb this year.

It bounced up to 2.901% the next day, following the jobs report that suggested the economy was still growing moderately; twoyear Treasuries yield remained at 2.76%.

“An inverted yield curve on a sustained period of three months, would presage a recession in about a year,’’ said Lee Heng Guie, executive director, Socio Economic Research Centre.

High frequency macro data still points towards strong headline US growth numbers in the next few quarters.

But the likelihood of future negative shocks should not be under-estimated.

“In fact, the probability of a weaker US economy in the second half of next year has gone up, even without any further rate hikes,’’ said Nor Zahidi Alias, chief economist, Malaysian Rating Corp.

The waning effects of US fiscal measures and lower capital spending on the back of cheaper oil prices and a stronger US dollar are factors that lead to the weakening.

Falling US equity price will negatively affect business and consumer sentiment, with adverse economic repercussions in the second half of next year.