Friday September 11, 2015 - 16:20:23 GMT
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Week Ahead: ECONOMIC DATA ANALYSIS 11 SEPTEMBER 2015
FED DECISION ON A KNIFE EDGE
FOMC faces a key decision whether to raise rates for the first time in this cycle
The arguments for and against are finely balanced, but we stick with our 0.25% hike forecast
Concerns about China likely to continue to weigh on markets
The FOMC meeting is the key event of the week. The outcome of Thursday’s US monetary policy meeting looks to be on a knife edge, with strong arguments for both raising interest rates and leaving them unchanged. If the Fed does move it would be a momentous decision, representing the first rise in US rates for nearly ten years. Members of the FOMC have been hinting for some months that they will probably raise interest rates before year end provided economic conditions evolve as expected. With only three FOMC meetings left this year we should now be approaching crunch time. However, FOMC members have sounded more cautious of late, as uncertainties about the Chinese economy have come to the fore. The lack of a clear message has added to the confusion in markets.
The arguments look finely balanced. There are several arguments for moving now. The improvement in domestic economic conditions suggests that the present emergency level of interest rates is no longer appropriate. Interest rates act on the economy with a lag and so it is right to move fairly early, particularly as that would allow the Fed to move more gradually. Finally, getting the first move out of the way could be seen as a vote of confidence in the economy and will remove a key area of uncertainty. The counterargument is that, with inflation still so low and markets so volatile, there is no need to hurry. Given concerns that current international uncertainties, particularly about China, could herald a downturn in global growth, it may be sensible to wait a little longer. We have long been of the view that a September hike was likely. Ongoing improvements in labour market data, which the FOMC has previously identified as a pre-requisite to tightening, provide support to this view. We are also mindful of the comments of some emerging market central bankers that it may be best to get an initial hike out of the way. However, the decision remains a close call.
Market reaction will depend on expectations of the next step. With markets putting less than a 30% probability on a September move, the initial reaction would likely be for the US dollar and US treasury yields to rise and equities to fall. The extent of this will depend on the expected path of further rate rises. Fed Chair Yellen will almost certainly use the press conference to reinforce the message that the FOMC expects to increase rates only gradually and that these will likely peak at a low level. The FOMC will also simultaneously publish the latest interest rate forecasts of participants and these may reinforce the gradualist message.
Chinese outlook remains uncertain. The outlook for China is likely to figure prominently in the FOMC’s deliberations. Data over the weekend for retail sales, industrial production and investment will provide further updates on the economy. The Chinese authorities have tried to send a reassuring message in recent days that both its currency and the stock market should stabilise from here. The implication would seem to be that further action will be forthcoming if that is not the case.
UK inflation to surprise on the upside. While UK markets will also be primarily focused on international events, domestic data will also be of interest. While the recent fall in the oil price raises the risk that CPI inflation (Tue) could have fallen back into negative territory in August, we do not expect that to have happened. Indeed, core inflation could surprise on the upside, despite recent sterling strength. Labour market data (Wed) will provide a further update on domestic inflationary pressures. We expect wage growth to have picked up only modestly in July. In a quiet week for the euro area the ZEW survey will provide an update on sentiment.
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