The Rate Hike Cometh: Fed Says Not Yet

September 17th, 2015 by

The Federal Reserve’s Open Market Committee (FOMC) concluded its two-day meeting on Wednesday and Thursday by announcing that no changes would be made to the federal funds rate, the central bank’s benchmark interest rate (generally used for overnight loans between banks).

Although this decision comes as little surprise thanks to months of nearly constant media coverage building the anticipation, it still likely signals some continued volatility in the bond and equity markets as traders must now wonder, Will the Fed simply delay its rate hike until October? or December? Will the central bank move interest rates at all this calendar year?

Mixed Expactations

Judging by trading of fed funds futures contracts, the traders in the bond markets implicitly gave about a 30% chance for the Fed to increase interest rates. Meantime, expert analysts at major banks were largely split, with some—like Goldman Sachs (NYSE:GS)—correctly predicting that the Fed would stand pat, while Bank of America Merrill Lynch (NYSE:BAC) had believed a rate increase was in the cards.

Richmond Fed Pres Jeffrey Lacker, typically a policy hawk, dissented from the rest of the committee in believing that the fed funds rate ought to have been raised by a quarter of a percentage point (25 basis points).

Rationale for No Move

inflation

Chronically low inflation (known as disinflation) and not necessarily turmoil on the global markets are the overarching reasons the Fed gave for its decision. This is despite robust indications from the labor market, as unemployment has steadily dropped over the course of the year—its lowest since April 2008. Although underutilization of the labor pool has gradually been improving, wage growth has remained slow with the lack of inflation. As measured over the one-year period up to August 2015, U.S. inflation was a measly 0.3%, laughably short of the Fed’s 2% target for healthy growth.

As usual, the statement from the FOMC focused almost entirely on low inflation and still more improvement in the labor market (a case of the Fed merely moving its metaphoric goal posts even further up the field, as headline unemployment has blown through previous “target levels”). The fluctuations and uncertainty plaguing the global economy were discussed only indirectly as a factor that will likely continue to hold inflation rates down.

Reaction to the Fed Announcement

Fed Chair Janet Yellen

Fed Chair Janet Yellen

The 10-year Treasury yield dove 5 basis points lower to 2.23% right after the announcement, as demand for government bonds was reinvigorated with the Fed putting off any potential rate hikes for at least another month, perhaps longer. Especially with the Fed quietly slipping the China/global turmoil under the blanket topic of inflation, the central bank has cleverly baked in a way to put off raising rates anytime soon without admitting that the U.S. economy may be subject to such factors overseas.

Meantime, traders piled into gold following the decision, helping spot gold surge as high as $1,132/oz (+$14) before settling more than $9 higher than were it started.

Considering that the upheaval in the Chinese markets is unlikely to abate anytime soon, it would appear that the FOMC has a ready-made explanation in the event that it again decides not to raise rates in October, or even December.