There is no clear answer whether or not the Federal Open Market Committee will hike the Federal Funds Rate at their meeting on September 17th. As the world eagerly awaits the verdict, the probability for a Sep hike have dwindled down to just 28% from 50% just weeks ago as China Growth concerns have rattled the markets and caused investors to pare back risk appetite. Recent Fed commentary has had a dovish tone and economic data since the last Fed meeting, in Jul, have been mixed. All in all, it remains a very close call this time around.

The Second Quarter GDP preliminary estimate arrived weak at 2.3% vs 2.6% (exp) but was later revised higher to 3.7% in the second GDP revision showing that growth was on track in Q2.

Activity in US manufacturing remains positive on balance, with most readings arriving above the critical 50.0 bullish signal threshold. Non-manufacturing has been strong with an Aug reading of 59.0 vs 58.0 (exp), and wide upbeat reading for Jul of 60.3 vs 56.3 (exp).

Headline employment readings have been weak contrary to the substantial downtick in the unemployment rate, which declined to 5.1% from 5.3%, as it continues to inch towards the Fed’s notion of “full employment”. The payrolls number for Jul arrived slightly lower than anticipated at 215K vs 220K (exp), but was acknowledged by the Fed, and the marketplace at large, to be consistent with a “solid” pace in employment growth. However, the most recent Aug reading arrived much weaker than expected at just 173K vs 225K (exp) and violated the 200K level. Markets viewed this as a potential impediment to a Sep Fed rate lift-off.

Core inflation measures are firmly anchored, and well below the Fed’s 2% threshold. The Fed’s preferred metric, PCE Core y/y, sits at 1.30% as per the latest release. Headline readings have also been constrained, on the back of transitory factors such as persistent and unusually low crude oil prices.

The bevy of economic data released since the last Fed meeting have not pointed towards a clear-cut policy decision. Earlier this summer, markets were pricing in greater than a 50% chance of two 25bps hikes before the year’s end, amidst a healthy amount of hawkish rhetoric out of several Fed committee members. Currently, there is a 28% chance for a Sep Fed rate hike priced into the OIS curve and Fed committee members have voiced their concerns over hiking rates at the Sep meeting. Recently a much more dovish tone has been widespread in the marketplace as China growth concerns have taken center stage.

Fed member Dudley (2015 Voter) stated, outright, that a Sep rate hike is “less appealing”. Fed’s George (Non-voter) also expressed concerns over the recent volatility. She expressed that it may bring about “complications” for the FOMC going forward and that the committee will have to observe whether or not the economy can withstand a rise in interest rates. Fed Arch Hawk Bullard (Non-voter) explained that the volatility in markets may not be “radical” enough to delay rate lift off, but also said that the committee may be more cautious of lifting rates if the “volatility” continues into Sep. Fed’s Fischer (2015 Voter) added that it is too early to make a decision on a Sep hike. As expected Fed Arch Dove Kocherlakota (Non-Voter) deemed a Sep hike inappropriate and prefers a delay until the second half of 2016. All in all, the hawks were cautious, the neutral members were dovish, and the doves were dovish in their communications.

Risk-off sentiment has been prevalent in US markets as traders and investors respond to woes abroad. The S&P 500 is offside 171 pts, since the last time the Fed met, at 1961.05, down 8.0% from July 2132.00 high. Fed watcher Jon Hilsenrath expressed that “Fed officials are far from an agreement whether to begin the rate lift-off ahead of the Sep Fed Meeting”.

In the past, former FOMC Chair Bernanke has used the Jackson Hole Economic Symposium as an outlet to break major policy news. The Fed’s QE program was announced at the event. However, Fed Chair Yellen was absent from this year’s symposium (Aug 27-29) and she has forgone the opportunity to offer up any information to tip off which way the Fed is leaning as they head into the Sep meeting. Some feel as though this may be a sign that the committee felt no immediate urgency to prepare market participants for a change in policy, just two weeks ahead of the Sep Fed Meeting.

The FOMC meeting minutes released Aug 19th, showed that there seems to be a divided Fed, with no concrete plans for the timing of the first hike. The Fed expressed concerns over growth abroad feeding-back into the US economy, “several participants noted that a material slowdown in Chinese economic activity could pose risks to the U.S. economic outlook”.

The Fed, in their minutes release, also revealed that committee members have some concerns domestically, as they nodded to soft business investment and an uncertain path for wage growth. Members of the committee took a wait-and-see tone during the last meeting and the minutes showed that, “members generally agreed that additional information on the outlook would be necessary before deciding to implement an increase in the target range.”

As it stands, markets are unclear on whether or not the Fed will go ahead with their first interest rate hike on Sep 17th. The economic data going into this meeting has largely arrived mixed but with a positive lean to it, The most recent Fed communications have been dovish in contrast to prior months hawkish rhetoric, and growth tensions abroad have continued to cause excess volatility that have sparked concerns for policy makers and market participants alike. One thing is certain, and that is, in recent weeks expectations for higher rates have been dialed back substantially.

Some believe that if the Fed does decide to hike at the Sep 17th meeting, it will be a very “dovish-hike”. This may seem like an oxymoron, however if that scenario materializes, the Fed is likely to explain that the pace of tightening going forward will be very gradual and Fed’s economic forecasts are likely to soften, which may minimize expectations for further hikes in the near term. Most do not expect repeated single meeting spaced consecutive hikes, and the Fed will likely reinforce that view.

In the event that the Fed chooses to take a wait-and-see approach instead, many feel that the December 16th meeting would become the next most likely candidate for the first Fed rate hike, in line with economic developments leading into that meeting. The October 28th meeting, the only other meeting left for the year of 2015, aside from Sep and Dec, may be a less likely candidate for the first rate hike.

There is no accompanying press conference scheduled for the October meeting like there is in Sep and Dec, which may limit its utility to the Fed, as transparency will be of paramount importance on the day that the committee decides to raise rates.

The only additional significant data points leading into the meeting next week are US retail sales and CPI, with core readings currently expected to arrive 0.40% and 0.10% respectively. The results of those reports are unlikely to cement expectations for a policy decision regardless of how they print. The Fed committee faces a difficult decision this time around and there is no clear signal as to which way the final results will render.

For market participants that are carefully eyeing the results, an abbreviated parse of the most important lines of the last Fed Statement, with keywords bold, and a copy of the Economic Projections of Federal Reserve Board Members is provided below. This should allow for quick Fed language comparison analysis with statement that will be published on Sep 17th, 2015 at 2:00 PM (ET). Please note that there will also be a press conference, after the statement is released, at 2:30 PM (ET). This link will lead you to the live FOMC press conference video stream.

Last FOMC Statement (Jul 29th 2015):

  • “…economic activity has been expanding moderately in recent months”
  • “The labor market continued to improve, with solid job gains and declining unemployment”
  • “Inflation continued to run below the Committee’s longer-run objective…”
  • “Market-based measures of inflation compensation remain low; survey based measures of longer-term inflation expectations have remained stable…”
  • “…economic activity will expand at a moderate pace…”
  • “The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced…”
  • “Inflation is anticipated to remain near its recent low level in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term
  • “The federal funds rate remains appropriate…”
  • “It will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term”

Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20150617.pdf

-David Felkai

Uptick GMA.

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