Markets have been talking about a September US rate rise for a year but the July minutes from the US central bank's Federal Open Markets Committee (FOMC) have sparked concrete doubt that the US Fed will actually hike rates in three weeks’ time.
The FOMC determined that conditions for rate hikes had not yet been achieved and remain worried about spill-overs from slower growth in China and the growth and inflation effects of a stronger US dollar (which have the same effect as rising interest rates as they tighten financial conditions).
Despite these concerns the members thought that the conditions required for a rate rise are now approaching. However, the comments about US inflation and the US dollar were minuted before China announced changes to its exchange rate regime.
The US Fed has singled out unemployment and inflation as its key data points, but one would seriously question how they could be more confident inflation is rising towards the +2% target in September than they were in July. Especially given:
- volatility in foreign exchange markets
- plummeting commodity prices
- half the components of the US core inflation measure have declined over the past six months
- further weakness in emerging markets where deflation is becoming a real threat.
No time to punt
In short, we are in the middle of a major risk event and now is not the time for policy experimentation – especially as US inflation remains extremely low and is unlikely to hit the +2% target until 2017.
The US Fed is clearly divided about its next move – counterbalancing the strength of its own economy and the fragile global recovery. To add the human element to the mix (and to remind ourselves of the turmoil of the past few years) it’s worth noting that few Fed members have actually ever voted for higher US interest rates!
That puts Janet Yellen in the hot seat and in many ways her legacy will be governed by how she engineers, markets and manages rate normalisation.
The outlook for rates
The key here will be consistently informing investors that data will be continually assessed, the recovery will not be endangered by policy changes and that US rates will remain highly accommodative. I don't think the second point can be justified and believe that US rates will remain unchanged in September. Indeed, the odds that US rates will remain on hold in 2015 must be growing by the day.