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Countdown to a March Hold

Posted by Joseph Trevisani on Feb 18, 2016 7:25:06 PM


Judging from the minutes of the January FOMC meeting released Wednesday, there is a greater chance of a rate cut in March than there is of a hike.  Not that either chance is more than remote.

It is possible to imagine any of a number of events that might induce the Fed to drop rates, a terrorist attack in the United States, a market crash or war in the Middle East, even if current economic conditions do not warrant central bank action.

But after sifting the FOMC's comments and noting the board’s concerns and reading into the minutes the uncertainty of the governors over the economic prognosis and the rising risks to the U.S and global economies, it is almost impossible to imagine a set of circumstances that would induce the governors to vote for a rate hike in March.

This is a rather astonishing turn of events. It was just two months ago, at the last FOMC meeting on December 16th that the Fed's own consensus, the famous 'dot plot’ projected four 0.25 percent increases in 2016. 

 Herewith the Fed governors’ likely concerns, some stated some not:

China's economic slowdown is a huge risk for global growth and stability. It was Beijing’s surprise devaluation of the Yuan in August that ignited the current market turmoil.  China has not helped by attempting to control its equity markets with several maladroit moves than only underlined the illiquid nature of the mainland stock markets. 

China’s January loan allotment, a record 2.510 trillion Yuan, greater even that the March 2009 financial crisis boost of 1.892 trillion, is a tangible sign that things on the mainland are not what the government says that they are.  The lack of transparency into the state of the Chinese economy and the distrust of the official statistics make the situation markedly harder to assess.

Global financial market volatility is unsettling the FOMC members.  One of the chief rationales behind the zero rate policy and the various quantitative easing interventions was the supposed ‘wealth effect’ of equity and asset prices on demand.  Make equity owners feel wealthier and they will spend more and eventually prompt the economy into a self-sustaining recovery. At least that was the theory.  

Unfortunately for the Fed this notion works in reverse too.  Large declines in equity and asset prices may foment a drop in consumption, undermining whatever boost to the economy the asset and equity bubbles may have provided.  In the weakening state of the global economy a substantial drop in U.S consumption would be a major concern.

The Fed seems surprised at the extent of the market reaction to a mere 0.25 percent increase.  They have to be asking themselves, what will happen if we continue?

Finally, “a number’ of Fed officials are starting to question the accuracy of the bank’s inflation forecasts.  The arrival of the Fed’s 2 percent inflation goal has been continually pushed into the future. It is now supposed to arrive at the end of 2017.  If there is no confidence that prices are responding to the Fed’s previous monetary ministrations, how can the FOMC take actions that, by their own policy understanding, should bring down inflation?

The Fed is discovering that in the real world the virtuous desire to ‘normalize’ interest rates is not enough.


Joseph Trevisani

Chief Market Strategist

WorldWideMarkets Online Trading

Charts: Bloomberg





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