US Fed decision’s market impact
Dear Traders,
21 September marks an important event for financial markets, as the Federal Reserve System (Fed) decides their Federal funds rate.
Markets are betting the Fed leaves rates unchanged, but nothing is certain.
For example, Barclays Investment Bank Economist Robert Martin, believes the Fed might hike this September.
I personally don't think the Fed will go up and if you want to learn why - keep reading.
And if you are not interested, that's fine too - you can always practice possible scenarios on a risk and cost-free demo account.
Presidential elections
So what do presidential elections have to do with a rate hike?
A lot.
For example, a September hike could break the U.S. central bank's tradition of no surprise tightenings during election years.
And this includes November, as the meeting would be only days before the election.
Trade protectionism
If Trump wins the elections, he will try to increase trade protectionism because it's the centre of his strategy.
I personally think that with Trump heading the USA, there will be:
- more market uncertainty than with Clinton in charge, because of
- Trumps probably numerous policy changes.
The contrary theory of protectionism implies leading to less importing and more domestic production.
Less importing means less USD is being sold in a way and that can improve the US Trade Balance i.e. better trade balance is theoretically better for the currency itself.
The other lag effect of protectionism, is a probable tax increases on imports:
...which in theory means raising taxes on imports to create inflation.
So, according to the logic above - there shouldn't be any hike before the elections.
Employment, equities and bonds
The Fed requires full employment (i.e. below 5% unemployment) and inflation at 2% per annum, to satisfy the conditions for a possible rate hike:
...so it's unlikely that we will see a rate hike (given annual CPI is currently at 1.1%).
This is unlikely to cause much change to the pricing of bonds - particularly US Treasuries - because the central bank rate will be unchanged.
But, this may lead to a temporary risk-on environment where equities may rise in the short term.
Warning - I suggest trading even more carefully than usual over this period.
Why?
Because most Indices have retreated from recent highs in the last week, so market direction may still be trending lower.
As for the USD, sure it may cause weakness:
… but as the market largely does not expect a rate hike…
...it probably won't cause large volatility with this currency.
So which is more important for the Fed to base its monetary policy around - employment figures or inflation levels?
In short, both.
But as we know the USA is running at full employment, perhaps more emphasis will be on inflation levels.
Inflation as a longer term problem
It's possible that cheap credit may create a vicious cycle of credit binging, which will inflate asset prices.
Though this does not appear to be the current case, given the USA has been running low interest rates for several years now.
Most western economies are facing weaker demographics, because the next generations are smaller in population size than the baby-boomer's era who are now:
- retiring
- consuming less.
The weaker demographics is more pronounced in European countries and Japan.
However, based on peak spending for the average human around 40 years old - US figures point to moderate consumption:
...especially when they need to up-size their homes and send children to school.
Next Fed rate hike
By reading this article you might be wondering if I expect any rate hike at all.
Of course I do.
But as explained above, I believe it will:
- be when the US inflation rate hits the 2% per annum target rate
- not happen the elections.
With the Inflation rate at 0.8% per annum last month, we need to keep an eye on raw commodities prices - especially Crude Oil, which feeds into prices across the spectrum.
As we are heading into a general presidential election in the USA, I expect the US Fed to sit on the sidelines until then at the very least.
In fact, I might be thinking contrary to many analysts and some major banks because I:
... don't expect the rate hike pace to accelerate in the upcoming months…
...expect the Fed to be quite cautious with their rate hikes over the next three years.
So traders, get prepared for FOMC and rate announcement.
I will be focused on equities movement and USD/JPY particularly.
Whatever the decision might be, we are there to follow it.
If you have any questions, please don't hesitate to ask in the comment below.
Cheers and safe trading,
Nenad
