We were wrong about the timing of the first Federal Funds rate hike in almost 10 years. Citing concerns over the global economic and financial outlook as well as the lack of inflationary pick-up, the US Federal Reserve chose to defer their rate hike decision once again. Janet Yellen, Chairperson of the US Federal Reserve, cautioned that uncertainty over global economic growth prospects and recent financial markets turbulence may trigger a slowdown in US economic activity and exert downward pressure on near term inflation.
For us, three things stood out – the focus on developments in the international arena which goes against the US Federal Reserve’s stated policy of basing its decisions solely on domestic considerations; Yellen’s very obvious dovish stance; and the fact that the Federal Reserve’s dot plot shows that a member of the FOMC (Federal Open Market Committee) actually forecasted negative interest rates. Granted, the US Federal Reserve will look at global growth and financial conditions as these may impact America’s growth potential. However, it is extremely unlikely that these conditions will measurably improve before this year end. As such, it is unclear how the US Federal Reserve will be able to raise the Federal Funds rate anytime soon if this remains a significant factor in their decision making.
What is likely to change between now and end of the year and where does this leave us? China’s economy is clearly slowing. This does not augur well for the commodities complex; prices are likely to continue moving lower. Emerging markets that rely on commodity exports will bear the brunt of this but America will not be immune. If 3 rd Quarter growth in the US turns out to be lower than the previous Quarter’s, we believe it is highly unlikely that we will see a rate hike this year or next. Also, 2016 is a US presidential election year and it may be politically difficult for the US Federal Reserve to move interest rates higher.
As some financial market commentators and strategists have recently highlighted, the US Federal Reserve is now left with two main monetary policy tools – more QE (quantitative easing) and negative interest rates. As we noted above, a member of the FOMC has already signaled that negative rates should be considered. However, this is unlikely to be the US Federal Reserve’s first weapon of choice should weakness appear in the US economy or a recession looms. We suspect that the first response by the Federal Reserve will be more QE.