09:00 AM (EST) Update
Fed head Janet Yellen delivered some optimism to the market yesterday, by putting a December rate rise back on the table. She said that along with a number of her colleagues, the Fed expects to raise rates later this year and then continue on a gradual path of monetary tightening. This brings two points to play; 1, they’re still willing to raise rates and; 2, it’s not going to be a case of ‘one and done’, they’re indicating that after they raise rates once, they’ll then be looking toward a second time.
In her hawkish side of speech, she said “Most FOMC participants, including myself, currently anticipate that achieving these conditions will likely entail an initial increase in the federal funds rate later this year, followed by a gradual pace of tightening thereafter.”
However, because she is Janet Yellen she had to follow these optimistic remarks with her usual words of caution, saying that Fed officials are unsure how long the headwinds to the domestic economy might last and that any negative surprises could still lead them to drop their tightening bias. She also pointed out that the U.S. economy is moving closer to full employment but that inflation has continued to run below their long-run target.
Here are the interpretations we can get from Yellen’s testimony.
1- Yellen and her gang are just showing optimism to avoid a market crash; No rate hike EVER
Yeah I kinda started with the gloomy interpretation. After all, Yellen did also mumble something like “ah, maybe this year, maybe next year, maybe never” the other week. This interpretation could be the voice of the doctor glooms and dooms of the market who keep yelling that the economy is about to crash, the Fed is full of BS and the world is coming to an end. While they may have a tiny point (who really knows what’s gonna happen tomorrow after all?) there are other market participants who are a bit more positive than this.
2- There will be a rate hike, but not this year
This is the voice of those market participants who thing October is too soon, and December’s markets are too thin and risky for a rate hike. Even thought we’ve had a gradual improvement on US employment and economy, China and other problematic countries would prevent the Fed from pulling the trigger too soon. This seems to be the thoughts of the majority of the market so far, since many dollar bulls dropped out today after yesterday’s rally.
3- December rate hike will be Fed’s Christmas gift to the market
Before Ms. Yellen, it was Atlanta Fed President Dennis Lockhart who reiterated that the U.S. economy is performing solidly even with all the financial market volatility and uncertainty. “At this point, my summary assessment is that the sources of uncertainty that fueled financial market volatility represent a modest risk to our economy, but a risk factor nonetheless,” he pointed out. Just like Williams, he acknowledged that the labor market is doing mighty fine but cautioned that inflationary pressures remain subdued. He also zoomed in on wage growth, citing that some degree of slack is present but that upward pressure is evident.
“As things settle down, I will be ready for the first policy move on the path to a more normal interest-rate environment. I am confident the much-used phrase ‘later this year’ is still operative,” Lockhart emphasized. “Once normalization is under way, I anticipate a gradual pace of rate increases.”
4- Rainbows in the sky! Love is in the air! Rate hike October this year!
This is the voice of the bright and sunny market participants who only see the good in everybody. While there is nothing wrong with being optimistic, if the Fed is prepared to raise rates, they must think the current global economy is able to cope with such a move, if they think that then the market can take some confidence and that confidence has translated into a bit of risk appetite. This has been reflected in emerging market currencies, that have reversed all of their losses from yesterday – and then some – and despite the traditional thinking of a rate rise boosting the dollar’s fortunes, the increased appetite for risk has seen flows out of the dollar and back into areas that were, up until last night, seen as no-go areas.
There, you have it. The 4 scenarios that could happen to the interest rates of the world’s largest economy. Which team are you with? Tweet me your take!