It’s all about the Fed
You’ve heard it said before that the Federal Reserve’s monthly rate decision is a major event for the world’s financial markets. This one is no exception and – forget jitters – has the potential to rock the markets. For the past several months, there have been numerous debates among the experts and the not-so-experts. Many feel it’s almost a no-brainer that the Fed is set to raise its benchmark rate.
The only question is when. Even the experts are in disagreement as to the timing with estimates that vary from sooner (say September) to later (December or beyond). The Fed has not been as transparent as markets would like on this question. But this week, it’s quite possible we may get a clear and concise answer. And because speculation and anticipation is so tremendous, markets are, in fact, quaking in their proverbial boots ahead of the decision.
First, a Fed Primer
The Federal Reserve Bank has been charged by the U.S. Congress with two specific mandates. First, they must adapt policy to promote full employment and second, they must ensure price stability. In that regard, the Fed has kept its lending rates at historical lows since December 2008. Every month, economic data drives the Fed’s rate decision, although some data carries more weight than other. Recently, though, there have been improvements in the US labor sector (mandate #1) while inflation and price inputs (mandate #2) have stabilized. Given that the Fed’s mandates are now finally being met, that begs the question: When will interest rates rise?
Crunching the Data
No one really knows. But Fed Chairman Janet Yellen gave us some clues a few weeks ago when she testified before the U.S. Congress. Fed officials, in fact, recently laid bare their best estimates on interest rate movement. What was made public was a matrix which showed how the Federal Open Market Committee (FOMC) viewed interest rates, past and in the future. The problem is, while each dot on the matrix represents a Fed voting member, it’s all anonymous. Janet Yellen’s dot – and really, the only one that matters in the grand scheme of things – is identical to everyone else’s.
However, testimony and recent comments made by Fed officials, including Yellen, offer some clues to solving the matrix puzzle. One notable Fed insider (Laurence Meyer, a former Fed governor) analyzed the graph and has drawn a few conclusions. In June, Ms. Yellen had said she expected to see only one rate increase in 2015. Meyer believes she needed to see more proof of a resurgence of the US economy. Recent Core Inflation data might be that proof, likewise the latest surge in consumer spending. Meyer feels that that might provide enough encouragement for the Fed Chairman (and other FOMC members) to reconsider the call for only a single rate hike this year.
Down to Business
There are three possible scenarios for the Fed interest rate decision. The Fed could stop prevaricating and drop a bombshell, announcing the decision to immediately raise interest rates. To a high extent that would be Dollar positive but would weigh on equities. If there is no surprise and the Fed decides to maintain the status quo, i.e. interest rates stay where they are, equities would get a boost. If that is the case, markets will want to scrutinize the Fed’s statement for underlying sentiment. A hawkish sounding Fed could still provide a lift to the Dollar.
On the Plate
Durable Goods Order(Tuesday)- If Durable Goods ex transportation gains more than 0.5% MoM it will be considered positive for the Dollar.
Fed Rate Decision(Wednesday)- If the Fed signals a rate hike is closer than before the Dollar could gain. If the Fed will be less upbeat than expected the Dollar could face some selling.
US Q2 GDP Growth(Thursday)- If US GDP growth beats estimates and posts a gain of 2.8% annualized or higher it will be considered highly positive for the dollar.
Chart of the Week – GBP/JPY