The coming FOMC meeting is likely to be closely monitored by the market, despite an overarching view that no action will be taken on monetary policy by the Fed. However, the sentiment of the meeting will likely be analysed for any hints of softness within the US economy given the recent turmoil around the world.
The US Federal Reserve embarked upon a phase of interest rate tightening in December that saw the Federal Funds Rate increased by 25 basis points. This hike in rates was subsequently followed by a range of expectation-setting statements that implied that the Fed would lift rates at least four times during 2016 in an effort to effect normalisation. In fact, the central bank was particularly helpful to the markets by providing a dot plot projecting the hikes which was relatively easy for even floor traders to digest.
However, since the initial hike, global economic conditions have deteriorated significantly along with some sharp falls in both Chinese and US equities. In addition, world oil markets have been in strong retreat for most of the year and this is likely to have a sharp impact upon the US inflationary outlook. Subsequently, in light of these developments, the central bank’s forecast of four separate rate hikes now looks particularly like a chapter out of Alice in Wonderland.
Therefore, the market will be closely monitoring any statements from Fed members following the meeting for signs of dovishness that could delay, or indeed derail, the planned rate hikes for 2016. Although yesterday saw a limited sentiment swing away from the US dollar, any strongly dovish tones or suggestions of rate hike delays are likely to hit the currency sharply. Subsequently, expect to see some volatility around any member statements as the market seeks to get a glimpse of things through the looking glass.
Moving forward, the US Federal Reserve faces some hard choices as the global outlook for 2016 stalls. In fact, the US Advance GDP result is due out later in the week and could provide a window into a softening US economy. In addition, as both the Russell 2000 and the Transport indexes contract sharply, many are now pointing to the early signs of a recession. However, despite these concerning signs, the US economy isn’t quite at that point yet, but regardless, the future of any rate hike plans appears to be in peril.
Ultimately, FOMC members are unlikely to acknowledge any form of threat to their plans by hedging their bets with the old “data driven” mantra. However, a bubble is very evident in the US economy and it just happens to be the one surrounding the US Federal Reserve. Let’s hope cooler heads prevail in the coming months and we don’t “hike” ourselves into the very thing the market is scared of, a recession.