FOMC look-ahead


The US Federal Reserve’s FOMC (Federal Open Market Committee) meets again this week. It is a two-day meeting which concludes on Wednesday with a rate decision and formal statement. Fed meetings are always noteworthy but there’s a general feeling that this one will be something of a non-event. For a start this is a “second order” meeting that doesn’t include a press conference from the Chairman. Also, it comes less than six weeks after September’s when the FOMC held off from tightening – despite frenzied speculation over the summer that the Fed was preparing to move. There has been little change in the economic data since then so the bet is that the FOMC’s outlook hasn’t improved enough to hike rates now.
So the headline Fed Funds rate is likely to remain stuck in the 0.0 to 0.25% band that was introduced back in December 2008. This view is supported by a look at the 30-day Fed Funds futures. This is where investors back up their analysis with real money. According to this market it doesn’t look like there will be a rate hike this year, let alone this week. Current prices suggest US interest rates won’t hit 0.5% for another twelve months.
Nevertheless, analysts will focus on the Fed’s statement. They will be on the lookout for the inclusion (or exclusion) of specific words or phrases which give clues to the current thinking of FOMC members. In this way they will attempt to work out whether the door remains open to a December rate hike or not.
It is proving very difficult for the US central bank to pull the trigger and raise rates. The last time they did so was back in June 2006, so they are certainly out of practice. By some measures the US economy isn’t looking particularly robust. Growth is underwhelming while inflationary pressures (at least those measured by the Fed’s preferred metrics) are muted. In addition, FOMC members have expressed their concern about the economic conditions prevailing elsewhere in the world, with China a particular worry. No doubt they were also dismayed by the Chinese authorities’ inept handling of the summer equity market slump (threatening short-sellers with jail, for instance) and the surprise yuan devaluation.
Yet there is also an argument in favour of raising rates before the year-end. Some analysts suggest that in the “new normal” US GDP growth of around 3-4% annually is really pretty good, as is an unemployment rate which came in at 5.1% last month - its lowest level since April 2008. In addition, a rate rise this year would give the Fed room for a cut should the economy weaken appreciably in the future.
But there are concerns that the Fed may have already missed their opportunity to hike. The central bank passed on two obvious windows in March and June and then ducked again in September. While the Fed’s inaction has helped support equities and other risk assets, it looks as if the central bank has painted itself into a corner. 2016 is election year and the argument goes that the Fed will not want to raise rates ahead of the Presidential vote in case it triggers a recession or stock market sell-off which could affect the outcome. Of course, this also means that with interest rates stuck near zero, the Fed’s most likely response to another economic shock is to undertake another round of quantitative easing.
So perhaps that’s what we should be preparing for rather than monetary tightening. After all, last Friday the People’s Bank of China cut rates and reduced its reserve requirements. The day before ECB President Mario Draghi hinted that the central bank is getting ready to increase its stimulus programme at its December meeting. This Friday the Bank of Japan will have another opportunity to increase its own asset purchase programme. Given all this perhaps it’s a bit daft to believe that the Fed will want to buck the trend and send the dollar soaring in response.

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