The Fed Leaves Rates Unchanged
The “guidance” still points to a first hike before the end of the year. There were several reasons why the central bank decided to wait longer.
Two conditions should be met before a first hike: 1) an improvement in the labor market and 2) the confidence that inflation start normalizing towards target levels. Out of those two conditions only one is satisfied. Indeed the unemployment rate suggests that the economy is close to full employment. However confidence in the inflation outlook hasn’t been established, especially after the recent commodity shock.
The Fed signaled yesterday that it kept rates unchanged due to market turmoil. The uncertainty created by the recent confusion in the Chinese economy is casting a shadow on the world’s economy, by increasing the risk of global deflation, which could spread to the U.S. economy. The recent market volatility and further rise in US dollar have tightened financial market conditions, according to the Fed.
The outlook for the Fed
The Fed did not change its growth forecasts for the US economy, but lowered its rate forecasts ("dots plots"). We however continue to expect that the Fed will start hiking rates in December 2015. Postponing the move into 2016 could send a negative message to investors regarding the health of the U.S. economy. Further, we expect a stabilization/improvement regarding the newsflow around China while oil prices should move to a USD 50-60 range over the coming months. That should help meeting also the second condition – i.e increase the probabilities of a normalization of inflation rates towards target.
Markets reactions
Despite the re-affirmation that the Fed will raise rates this year, market reactions are mixed as uncertainties remain in place.
On stock markets, the S&P500 index closed at -0.3% yesterday. This morning, Asian equities are slightly positive while European futures indices are slightly negative.
The US dollar fell to 1.140 compared to the euro from 1.130.
The US 10-year rate declined slightly. The 2-year bond yield dropped more significantly, implying a steepening of the yield curve.