As the Federal Open Market Committee (FOMC) gathers for its September meeting today (September 21st), all eyes are on whether the Federal Reserve will hike rates for the first time this year.

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Hike or hold?

 

How would markets handle a Fed rate hike? In a word, badly. Markets have all but priced out a rate rise and would be sent into a flat spin if the FOMC members vote to tighten. CME’s FedWatch tool indicates just a one in eight chance the Fed will pull the trigger.

Beware complacent markets. After a long summer lull in which volatility sank and equities powered to record highs in the US, something has to give. A ‘surprise’ rate hike could be the catalyst and FOMC members are arguably closer to tightening than markets think. Most want to raise rates, the only question is the timing.

Hawks v doves

 

If the Fed holds off, it’s going to be crucial to see how the votes fell. We know that Esther George voted to raise the target range for the federal funds rate in July. So will our leading hawk be joined by anyone else on the FOMC?

Boston Fed president Eric Rosengren could be one to watch. A leading dove, he’s lately indicated a change of view, remarking that easy money is bad for financial markets longer term. “The tools we have are quite blunt,” he said in an interview with the WSJ, suggesting that it’s better to act before problems manifest in markets. Delays in tightening could destabilise markets. “A failure to continue on the path of gradual removal of accommodation could shorten, rather than lengthen, the duration of this recovery,” he said.

If Rosengren has really shifted his stance this could fundamentally alter the centre of gravity in the FOMC.

Hawkish hold or dovish hike

 

Would a hold necessarily be ‘dovish’? Arguably not – if the Fed holds now and gives a bullish update on the economic outlook, then we have to be looking at a December hike. So a ‘hawkish hold’ could very well drive speculation that a hike is all but certain by the end of the year. Current market expectations suggest a roughly 50/50 chance that rates will be higher by December.

Data dependent

 

Whether the Fed hikes or holds, it will be important to consider how members view the US economy. Recent data has been a mixed bag, but it’s getting pretty close to being good enough to warrant a hike.

The labour market in particular looks strong, with a run of upbeat non-farm payrolls and falling jobless claims, although a slight slowdown in August dampened expectations. In fact we’ve had 80 straight weeks of jobless claims below 30,000, the best such run since 1970.

Meanwhile, inflation has edged higher since the last meeting and this could be pivotal for some members. According to the Labor Department, the Consumer Price Index increased 0.2% in August after being flat in July. In the year to the end of August, inflation rose 1.1% after advancing 0.8 percent in the year through July.

US elections

 

The elephant in the room is the looming US presidential election. Holding rates would amount to a non-decision and that may be exactly what members would prefer with the vote in November so close. A surprise rate hike would be a break in tradition. Its November meeting is only a few days before the election, which would seem unlikely and leave December the best guess at present. The Fed could yet choose to act decisively and early, but markets don’t seem to agree.