As widely expected following a run of mixed economic data, the US Federal Reserve remained on hold with the Fed Funds rate at 0.25-0.5% at its September meeting.
While the Fed judged that the case for a rate hike has “strengthened” and that the risks to the economic outlook are now “roughly balanced” and there were three dissents in favour a rate hike, the overall impression is that the Fed’s hawkishness is very mild. It is still waiting for more evidence of progress towards its objectives, Chair Janet Yellen repeated that the Fed can more effectively respond to rising inflation than to falling inflation as a reason to remain cautious, the Fed continues to refer to only “gradual” increases in interest rates and the Fed’s dot plot of Fed meeting participants interest rate expectations continues to decline. It’s now showing just one hike this year (down from four at the start of the year), only two hikes next year and expectations for the long run natural rate have fallen further to 2.9% (from 3% in June).
Based on the experience of the last few years it’s understandable that the market is sceptical of Fed rate hike expectations as they have been continuously revised down.
Our base remains for the Fed to hike at its December meeting, but this will require more consistently positive economic data from the US over the next three months. The US money market’s probability of a December hike is 61% and this sounds about right.
The bottom line is that with US growth running around 2% or a bit less and inflationary pressures remaining below target, global risks remaining and the strength in the $US over the last two years and the recent (regulatory driven) rise in US interbank lending rates doing part of the Fed’s job for its, the Fed remains rightly cautious in removing monetary stimulus. This is likely to remain the case for some time to come.
So for share markets the Fed remains broadly supportive, although volatility will no doubt increase again as we get closer to the December meeting.
For Australia, the ongoing delays in Fed rate hikes are a mixed bag. On the one hand a cautious Fed taking account of US and global economic conditions before raising rates is a good thing as it helps sustain global growth and hence demand for Australian exports. But on the other hand the continuous delays in Fed rate hikes are keeping the $A AUD/USD stronger than would otherwise be the case which in turn could dampen the ongoing rebalancing in the Australian economy. Thanks to the BoJ’s commitment to continue monetary stimulus for a lengthy period and the Fed’s decision to hold, the $A has bounced above $US0.76 again. Ongoing $A strength keeps alive our expectation for another RBA rate cut, even though it’s now a close call thanks to strong Australian economic growth.