Wednesday, September 16, 2015

The Fed's Big Decision?

Rupert Neate of the Guardian reports, All eyes on Federal Reserve as it prepares for interest rate announcement:
Under intense security and privacy, 12 people are gathering in Washington DC to make decisions that could change the lives of everyone in the US – and much of the rest of the world.

The Federal Open Market Committee (FOMC) will on Wednesday and Thursday thrash out a decision on whether to raise US interest rates, which have been held at near-zero since the 2008 financial crisis.
For months, economists had been expecting a rate rise (dubbed “liftoff” by Fed officials) at this meeting, but their enthusiasm has waned markedly following last month’s global stock market panic over the health of the Chinese economy.

The decision will be announced by Federal Reserve chair Janet Yellen at a highly anticipated press conference in Washington on Thursday. Even if rates aren’t raised, every word that she says – and how it reflects the committee’s confidence in the US economy – has the potential to significantly move global markets.

The decision will be announced by Federal Reserve chair Janet Yellen at a highly anticipated press conference in Washington on Thursday. Even if rates aren’t raised, every word that she says – and how it reflects the committee’s confidence in the US economy – has the potential to significantly move global markets.

The FOMC members, who are often in close agreement, appear to be deeply split about whether they think the economy can handle an increase in rates, which could put companies off investing and hiring more employees.

John Williams, an FOMC member and president of the Federal Reserve Bank of San Francisco, has been bullish about the strength of the US economy for most of the year but appeared much more cautious last week.

“All of the data that we have had up until now has been, I think, encouraging,” he said in an interview with the Wall Street Journal. “But there are some pretty significant – and I would say have now grown larger – headwinds that have developed.”

His counterpart from Minneapolis, Narayana Kocherlakota, is even less confident. “I don’t see a near-term increase in interest rates as being appropriate, and by near-term I mean really through the course of 2015,” he told CNBC at the recent central bankers jamboree in Jackson Hole, Wyoming.

Bill Dudley, the president of the New York Federal Reserve and the most important US central banker after Yellen, has also said the idea of raising rates this month isn’t as “compelling” as it was before the China-led stock market chaos.

On the other side of the table, Stanley Fischer, the Fed’s vice-chairman, has said recent “impressive” jobs growth – to the level the government considers effective full employment – creates a “pretty strong case” to raise rates in September. “We’re getting back to normal and at some point we will want to show that, by beginning to normalize interest rates,” he said recently.

Eric Rosengren, president of the Federal Reserve Bank of Boston, reckons employment conditions needed for a rate rise have “largely been met”, but he is less certain on inflation. “Recent reports on wages and salaries still show few signs that the tightening labor markets are translating to increases in wages and salaries consistent with reaching 2% inflation,” he said.

US prices have risen by 0.3% over the past year, and inflation has lingered below the Fed’s 2% target for more than three years.

Goldman Sachs analysts this week said in a report they expect rates to be left unchanged, but think the Fed will signal that “liftoff is near”.

ING economists said Thursday’s decision will be “the most eagerly awaited in years”, though they also expect rates to be left unchanged – “but this is a very close call”.
CNBC reports for the first time in the five-year history of the CNBC Fed Survey, a plurality of respondents forecast that the central bank will raise rates at the current meeting:
Despite harrowing market volatility and rising anxiety over global growth, 49 percent see the Fed hiking rates this month. Of the 51 economists, money managers and strategists who responded 43 percent say the first hike will come later, down 4 points from the August survey. The percent saying they are unsure rose to 8 percent from 5 percent.

"It is time for the FOMC to start bringing monetary policy slowly out of its 'self-induced coma' in response to much improved vital signs for the U.S. economy," said Stuart Hoffman, chief economist of PNC Financial Services Group.

In fact, respondents have rethought their forecasts from the nervous days of August and moved ahead their forecasts for nearly all monetary policy moves. They now forecast that the Fed will begin reducing its balance sheet in August 2016, compared to September in the prior survey. The Fed is forecast to finish hiking (or hit its "terminal rate") this cycle in the first quarter of 2018, six months earlier than the previous call.

"The 'data dependent' Fed has all it needs to hike rates," wrote Jim Bianco, president of Bianco Research. "If they do not, it is because of 'financial stability' concerns. If they do hike, they are announcing the stock market's volatility does not matter."

The market continues to call for a very modest set of increases, with the Funds rate ending 2015 at just 37 basis points and 2016 at 1.17 percent. The terminal rate is forecast to be only 2.7 percent.

Calls for a hike come with global growth worries remaining center stage. It was chosen by 45 percent of respondents as the No. 1 threat to the U.S. recovery, up from 29 percent in July. And the chance of a recession in the next 12 months, though it remains low, rose for the third straight month to 18.6 percent, a three-year high.

Most, however, sided with Constance Hunter, chief economist of KPMG LLP, who said, "The Fed should raise in September as the economy is strong enough to withstand a normal low-rate environment."
And Steve Goldstein of MarketWatch reports, When is the Fed decision?:
The Federal Reserve this week could announce its first interest-rate hike in nine years.

The Federal Open Market Committee statement containing the answer to the question of whether there will be a hike or not is set to come at 2 p.m. Eastern on Thursday.

The Fed will simultaneously release its new economic projections and interest-rate forecasts at 2 p.m., and Chairwoman Janet Yellen is slated to speak to the press at a 2:30 p.m. press conference.

The current consensus of Wall Street economists is that the Fed will wait until October at the earliest to raise rates, given concerns about China and recent surveys showing weak consumer and business confidence. But a minority say the rate increase will come on Thursday, and in futures markets traders are pricing in a 1-in-4 chance of a September hike.

A former aide to Janet Yellen told MarketWatch that the September rate decision is a toss-up.
It certainly is a toss-up but if I was on the FOMC, I'd be arguing hard to stay put for the rest of the year until we see concrete evidence that inflation expectations are picking up.

In fact, Matthew Boesler of Bloomberg reports, U.S. Inflation Expectations Are Lowest in Years, Fed Survey Shows:
Consumer expectations for inflation three years ahead fell last month to the lowest level in records going back to June 2013, according to a Federal Reserve Bank of New York survey released Monday (click on image).

The median respondent to the New York Fed’s August Survey of Consumer Expectations predicted annual consumer price inflation three years hence would be 2.9 percent, down from 3 percent the month before. Median expected inflation a year ahead fell to 2.8 percent from 3 percent, marking the second-lowest response in the history of the survey.

The results come ahead of Sept. 16-17 meeting of Fed policy makers in Washington at which Fed Chair Janet Yellen and her colleagues will debate whether to raise interest rates for the first time in nearly a decade.

Officials said in a statement following their last meeting in July that they needed to see “some further improvement” in the job market and be “reasonably confident” in the inflation outlook. Their preferred measure of prices, the personal consumption expenditures price index, was up 0.3 percent in July from a year earlier and has run below the central bank’s 2 percent target for over three years.

Fed Vice Chairman Stanley Fischer attributed much of the current shortfall to the recent drop in oil prices and appreciation of the U.S. dollar during an Aug. 29 speech in Jackson Hole, Wyoming.

“Given the apparent stability of inflation expectations, there is good reason to believe that inflation will move higher as the forces holding down inflation dissipate further,” Fischer said.
I think Stan Fisher is extremely optimistic when it comes to inflation expectations. I've long argued the Fed has a deflation problem no thanks to the mighty greenback and now China's Big Bang. I agree with those who think the Fed would be making a monumental mistake raising rates too soon (even if it's a "one and done" deal) and I would definitely heed the bond king's dire warning and stay put at this time.

But who knows? The Fed will pore over a mountain of domestic and international data to make its decision. Maybe it thinks a global recovery is around the corner and the rest of the world can easily withstand a 25 basis point hike at this time.

It's not the Fed's decision tomorrow which worries me, it's the follow-up and how it will spin this decision. I'll be watching markets to see how U.S. government bonds (TLT) and high-yield bonds (HYG) react over the next few days. I'll also be watching how interest sensitive sectors like utilities (XLU) and REITs (IYR) as well as financials (XLF) react to the decision.

Of course, I'll also be watching tech (QQQ) and more specifically the biotech sector (IBB and XBI) which I still like going forward, as well as many sectors leveraged to global growth like emerging markets (EEM), Chinese shares (FXI), energy (XLE), oil services (OIH) and metal and mining stocks (XME).

So relax, the Fed's big decision will soon be out of the way and we shall see if the real fireworks begin or if we can all breathe a sigh of relief. Either way, buckle up for a bumpy ride ahead!

Below, CNBC's Steve Liesman reports on a declining market outlook ahead of the Fed meeting. And Brian Levitt, Oppenheimer Funds, weighs in on why he thinks the Fed is unlikely to announce an interest rate hike after this week's FOMC meeting.

I agree with Levitt, in a world where deflation fears reign, the Fed would be nuts to raise rates at this time and is better off erring on the side of inflation. We shall see what it decides on Thursday.

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