I am increasingly of the expectation that the Federal Reserve will not move on rates in September. There are a lot of reasons why although the unemployment part of the Fed’s dual mandate may be a box that is ticked, inflation is certainly not. With commodity prices at multi-year lows and now a devaluation by China (which at 3% is unlikely to be the end), the forces of deflation are hitting the US. The FOMC has suggested that it wants to see inflation on the way towards its target before it hikes interest rates. Here are four charts that suggest the market is now seriously questioning whether the Fed will hike rates in September and a weaker dollar near term will be the result.
I think that the devaluation of the Chinese yuan this week has changed market expectations of a FOMC rate hike in September. I think that the deflationary impact of the yuan falling to its weakest against the US dollar for 3 years, will give the doves the excuse to hold off from a rate hike. The committee is naturally dovish (especially Fed chair Janet Yellen) and I think will need a lot more persuasion that inflation is set to return.
With the oil price falling back to six and a half-year lows this week and the move by China just adds to the deflationary forces that US is facing. Retail sales in the US remaining at multi-year lows (under 1% year on year growth) I see little prospect of inflation starting to move towards the Fed’s 2% target. The Fed is bound by law via the dual mandate and the fear that the doves on the committee will have would be that if it increases rates too soon, it runs the risk of pushing the US into deflation.
Look at the chart of the US yield curve. The front end has risen over the past month and the long end has flattened distinctly. This may be as a result of scarcity of Treasuries as much as it is a concern over future growth prospects. The US 10 year yield has been falling consistently over the past 5 weeks and is pushing on 3 month lows. The technical analysis suggests bearish momentum continues and is a drag on the yield. This is dollar negative.
This move is also being seen on the chart of the trade weighted dollar which completed a small top on Wednesday. The deterioration is confirmed on the RSI momentum indicator and suggests further downside from the breakdown of 96.30 to drop to 94.50. This move is also reflected in the charts of several forex majors which are increasingly showing signs of dollar selling pressure.
EUR/USD has already broken a sequence of lower highs and rallied to confirm a move above the medium term pivot band $1.1050/$1.1100. This puts the outlook for the dollar far more mixed now and the dollar bulls have lost control of the range again. There are other forex majors that are also showing signs of a dollar correction. Dollar/Yen is showing corrective signals and needs a move below 124.00 to confirm a near term correction. Dollar/Swiss is also another chart that is close to giving corrective signal, with a close below 0.9700 confirming a breakdown. Add in technical rallies on gold and silver, and the position of the dollar bulls is being seriously questioned.
I believe that this all reflects the market is dialing back on its expectations of a September rate hike, which is now very much in the balance.