Wednesday, December 16, 2015

No surprise: US Fed raises rates | Will inflation take over from jobs as the key indicator to watch?

The first interest rate rise in nearly a decade took place in the US yesterday, after being really well-signalled in advance. Now the focus of market participants and commentators must turn to the expected size and frequency of rate rises each time the Federal Open Market Committee (FOMC) meets through 2016 and beyond.

Many commentators expect that there will be a new rate rise after every second meeting of the committee, making for a total of four rises expected during next year. Experience would dictate, however, that fundamental economics are not normally that well-mannered and predictable. And the Fed is on record as saying, many times, that its decisions on interest rates and stimulus in general will be “data dependent”. That, of course, is good news for currency traders, who thrive on the levels of uncertainty that can lead to long-term volatility in Forex.

The rate rise yesterday had a tentative feel to it. Economic stimulus, in the form of the re-investment of the proceeds from maturing bond holdings that are left in the Fed’s treasury as an overhang from Quantitative Easing, will continue. Interest rate projections as far out at 2018 have been lowered by the Fed, and all the talk is of a very gradual and careful path back to normality. Expectations for GDP rises have also been curtailed slightly.

Inflation takes over from jobs as the key indicator to watch

But the biggest caveat of all has to do with inflation. The U.S., and the developed world as a whole, are a long way away from the 2% across-the-board rate of inflation that all would like to see. The downward pressure on consumer prices will continue for as long as energy and other commodities continue to fall, and yesterday oil took another sizeable hit (see chart above). A barrel of oil on the NYMEX exchange is now well below the $40 that many saw as a floor not too long ago.

The Fed has a dual mandate – it is responsible for controlling inflation as well as for stimulating and maintaining jobs. Up to now the U.S Non-Farm Payrolls figure each month has been the statistic that was most closely watched by the markets as the indicator of what the Fed might do. Are we likely to see the Consumer Price Index take over this role?

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