The huge increase in volatility on global financial markets in the past couple of weeks have dramatically changed the outlook for a September rate hike by the Federal Reserve. Just a few weeks ago, the majority in the media seemed to be convinced that a September rate was an almost nailed on certainty (not me I might add, I have been saying December for a while). Recently we have seen expectations of a Fed rate hike being pushed back. So with Jackson Hole about to kick off, where a raft of FOMC speakers take the floor to give their views on Monetary policy, where are we in terms of rate hike expectations?
Firstly, what are the Fed Funds futures saying? Well, they have been significantly scaled back in recent weeks. About a month ago, according to CME Fed Watch the chances of there having been a rate hike by the December meeting was up at around 62%. Following huge declines on the commodity markets (which is deflationary), disappointing economic data out of China (flash manufacturing PMI at a 77 month low signals big concerns over demand), a move to devalue the yuan by the People’s Bank of China (also deflationary), whilst adding in the significant market turmoil that has come with a massive market sell-off, the chances of a rate hike having been made by December are now less than likely. According to CME Fed Watch, the probability is now at 49%.
Looking at the chart of the Fed Funds futures December contract shows that the market is pricing it to an extent at which the chances of a December hike are around the lowest they have been this year (remember the inverse relationship between the contract and the chances of a rate increase). This is a significant change to expectations, especially in the past couple of weeks.
So, members of the Federal Open Market committee are already scaling back their arguments. Atlanta Fed President, Dennis Lockhart, said on Monday that whilst he still expected a rate hike this year, the recent dollar strength, Chinese yuan weakness and oil price declines were complicating the outlook. Lockhart did not comment on the prospects of September, which is seen as a subtle shift in his stance, considering as recently as 4th August he suggested that it would take a significant deterioration in the economic data to convince him not to move for a hike in September. Lockhart is seen as something of a centrist on the committee and could easily be a barometer for the general mood. If he is not going to vote for September then the chances of the majority of the voters to opt for a hike is extremely slim.
Then there is New York Fed President Bill Dudley said yesterday that the chances of a September rate hike were “less compelling” it would appear that the market has already moved to price it in. Dudley is a permanent voting member on the FOMC, however he is habitually on the dovish side of the debate on monetary policy.
The Jackson Hole economic symposium the market will show several more of the FOMC members giving their views and it seems likely that given the market turmoil of recent times, and if the comments from potential hawks such as John Williams and Jeffery Lacker are not deemed to be supportive of September then all talk of a rate hike in the next FOMC meeting can surely be put to bed.
If this is the case, then does December become last chance saloon for the hawks? The trend of core Personal Consumption Expenditure (latest data point is tomorrow) could be key in the coming months. However with the strength of the US economy, if they can’t move in December then do we get stuck in Groundhog Day? That discussion is probably best for another day.