Is the Fed Prepared to Hike?

September 15th, 2015 by

The big development that touches virtually everything else on the global markets is still whether or not the Fed will tighten policy when its Open Market Committee meets on Wednesday and Thursday of this week. Expectations by those supposedly “in the know” about how these things work have unreliably swung back and forth throughout the course of 2015, coming full circle to the present chances of a coin-flip.

Analysts are almost perfectly divided on whether or not they think the Fed will move this week—or, said differently, they are basically stumped. The 50-50 chance they give is no better than admitting that they have no clue.

Another factor that’s weighing on analysts’ predictions has been the mixed performance of the U.S. economy, as well as the spike in volatility on the global markets over the last month or so.

In some ways, economic conditions seem far better in the U.S. than overseas. Headline unemployment is low, the dollar has remained strong, and certain sectors of the economy (tech, healthcare) continue to see growth. The indicators about where the economy is headed are uneven, however. Although retail sales and consumer spending both rose during August, there are other signs that point to the economy underperforming.

Weak Data

factoryThe Empire State manufacturing index, a gauge of whether or not the sector is growing or contracting in the region, fell for the second consecutive month. This means that manufacturing in New York and the Northeast has been shrinking. Moreover, overall industrial production fell 0.4% during August, signalling some weakness in factory activity across the country.

Even though the drum-beat for a rate hike has been consistent (quieter at times this spring, louder during others) throughout the year, many wonder if the Fed can justify tightening policy in this economy? For one, productivity has been extremely low in the U.S. for an economy in expansion. This is a sign that people are working again, but employers aren’t getting nearly as much efficiency and output from each individual worker. In other words, it’s the kind of expansion that could fall back in on itself if firms decide the make their operations leaner and more productive.

Volatility

Another major factor that takes some of the luster off of U.S. economic performance has been the intensifying volatility. This trend has not been isolated to U.S. stocks, and in fact has been even worse abroad, especially in Asia.

Source: pgm-blog.com

Source: pgm-blog.com

Many FOMC participants have expressed doubt as to how market volatility should play into the Fed’s decision on rates. While this is a bold stance on not playing victim to the moment, it does come with certain risks. Will the stock market stabilize after a rate hike, or simply plunge deeper into volatility? During August, the VIX index (a measure of volatility) surged 135%, a monthly record.

According to Bloomberg,

“Since 1990, the measure of market turbulence known as the VIX has averaged 16.9 when U.S. policy makers started raising rates. It closed Monday at 24.25. If the Fed increases rates this week, it would be the first time since 1946 it has done so within a month of a correction.”

Europe and Asia

Meantime, data was likewise mixed in Europe. Auto sales in the EU jumped by 11.5% in August, showing some resiliency in consumer spending. However, a measure of investor confidence in Germany fell for the sixth consecutive month, while inflation remained grounded near zero in the U.K.

world

Asia was also somewhat of a mixed bag. The Shanghai Composite lost 3.5% overnight with extremely low trading volumes. In Japan, meanwhile, the central bank decided to hold its rates at their current levels rather than cutting them, choosing not to add any more bank stimulus at the moment. The yen firmed up, briefly falling below 120 per dollar. Most still expect the Bank of Japan to institute more monetary stimulus at its meeting at the end of October.