This is it.
The Federal Reserve meets on Wednesday and Thursday to decide if it will end the era of 0% interest rates, which it introduced in December 2008 in its effort to stimulate growth and inflation in the wake of the global financial crisis.
“The moment of truth is upon us, and the market will have much to digest this week as outcome of the September FOMC meeting and the post-meeting press conference provide some much needed direction to investors,” TD’s Priya Misra writes.
Recent comments from members of the Fed, including Chair Janet Yellen, suggest we could see the Fed initiate rate hikes before the year is over.
“If the economy evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the federal funds rate target, thereby beginning to normalize the stance of monetary policy,” Yellen said to Congress in July.
“The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labour market and is reasonably confident that inflation will move back to its 2% objective over the medium term,” the Fed said at the conclusion of its July FOMC meeting.
So far, it appears the economy has evolved as expected, the labour market has seen some further improvement, and, if you believe Fed Vice Chair Stanley Fischer, there’s “good reason to believe” that inflation will move up to the Fed’s objective.
But in an unexpected curveball, volatility has spiked in the global financial markets, turning the spotlight to the Fed’s unspoken third mandate of fostering financial stability.
“If domestic data alone were the issue, we’d be inclined to lift off in September,” Credit Suisse’s James Sweeney said. “But the timing of policy lift-off has become largely contingent on global conditions and financial market volatility, and in their view, these have combined to more than offset the good domestic news.”
Futures traders are currently pricing in a 28%. And while the consensus is calling for no rate hike on Thursday, there are a ton of economists who believe otherwise.
Here’s your Monday Scouting Report:
The case for a rate hike. While the consensus believes there’s a strong economic and financial market case for holding off on rate hikes, there are many who argue otherwise. UBS’s Drew Matus estimates theres a 60% chance the Fed hikes this week. “September has three advantages,” Matus writes. “1) It offers a compromise between hawks and doves, getting one rate hike “out of the way” without committing the Fed to more. 2) It provides optionality for those who anticipate that more than one hike this year would likely be appropriate (10 FOMC members, or the majority of the committee, as of June. Though likely there are now a few less). 3) It avoids any risks resulting from policy changes around year-end, when bank funding issues tend to become more complex.”
The camp forecasting some form of a hike in September includes Bank of America Merrill Lynch’s Ethan Harris, Wells Fargo’s John Silvia, Societe Generale’s Aneta Markowska, JP Morgan’s Michael Feroli, and Bank of Tokyo-Mitsubishi’s Chris Rupkey.
The case for waiting until December. Ever since June, the economics team at Goldman Sachs has been predicting that the Fed would make its first move in December. “Even if we focus only on the economic data, it is hard to argue that developments have beaten expectations on net,” Goldman’s Jan Hatzius and Zach Pandl write. “Although the growth data have been quite good and the labour market has improved further, both wage and price inflation have fallen short of expectations. Once we broaden the perspective to include financial conditions, developments have been worse than almost anyone expected.”
Others expecting liftoff in December include Morgan Stanley’s Ellen Zentner, Nomura’s Lew Alexander, Credit Suisse’s James Sweeney, and BNP Paribas’ Bricklin Dwyer.
The case for waiting until October. Deutsche Bank’s Joe LaVorgna can think of seven compelling reasons why the Fed won’t hike in September. He also thinks a December hike would be a mistake because as he wrote, “One, the optics of raising interest rates in the middle of the holiday shopping season are not good. Additionally, the financial markets are notoriously illiquid at yearend. Hence, a rate hike could cause an outsized reaction in the financial markets.”
LaVorgna sees October as a viable option, but he argues seven things need to happen between now and the October 27-28 FOMC meeting. From his note: “1) Global equity markets need to stabilise… 2) The Fed’s broad trade-weighted dollar index has to stop appreciating… 3) Key measures of economic activity such as housing starts, nonfarm payrolls and retail sales, variables that have been relatively strong, need to remain sturdy… 4) Core inflation has to stop going down… 5) Chair Yellen needs to repeat in her press conference that the October FOMC meeting is “live”, meaning the Fed could raise rates next month if economic and financial conditions warrant action. 6) Chair Yellen must repeat that the Fed has the ability to call an impromptu press conference to explain its action… 7) Most importantly, the financial markets have to be discounting a reasonably high probability of an interest rate hike.”
Since we’re talking about October, Morgan Stanley thinks it’s “highly unlikely” they’d hike in that month because “if not September, it is highly unlikely the Fed finds the data suddenly compelling enough to go in October.”
- The case for … 2016?! After seeing the spike in market volatility, the economists at Barclays went way out on a limb and moved their forecast for an initial rate hike to March 2016. They aren’t alone in that folks like bond god Jeffrey Gundlach think there’s a strong case for holding off until at least next year. Here’s Barclays’ Michael Gapen in a note to clients on Friday: “Should concerns about downside risk to global growth subside and financial market strains ease, then a rate hike before year-end is a strong possibility, in our opinion. More persistent growth concerns, heightened uncertainty, and a shallower inflation profile could delay rate hikes into 2016, as we currently expect. That said, we do not believe the committee is prepared to give up on a rate hike before year-end after preparing markets for so long. “Not now, but possibly soon” is what we expect to hear next week.”
- Retail Sales (Mon): Economists estimate sales climbed 0.3% in August. Excluding autos and gas, core sales are estimated to have climbed by 0.4%. Here’s Wells Fargo’s John Silvia: “With gasoline prices falling again, however, there is some downside risk to the top line number. Moreover, the turmoil in the stock market may have cut into discretionary spending, although there is no evidence pointing to that just yet. Back-to-school spending was largely reported to be disappointing, which should restrain gains at department and clothing stores. However, spending at home improvement stores may be a bright spot, as improving home sales and steady gains in home prices have bolstered remodeling activity. Restaurant dining also appears to be holding up well, benefiting from lower gasoline prices and stronger job growth.”
- Empire Manufacturing (Mon): Economists estimate this regional manufacturing index improved to -01.5 in September from -14.92 in August. Here’s Nomura: “The Empire State manufacturing report suggested that there was a sharp contraction in manufacturing activity in the NY region in August. This survey is sent to manufacturing executives and they might have been more sensitive to the volatility in financial markets and/or concerns about overseas. As such, we forecast that the headline index will bounce back from August’s negative reading of -14.9, but that it will remain low at -3.0 in September, reflecting the less favourable environment — strong US dollar, low oil prices, global growth slowdown – for manufacturers.”
- Industrial Production (Mon): Economists estimate production slipped by 0.2% in August while capacity utilization fell to 77.8%. From Credit Suisse: “Auto production schedules point to a large sequential decline (albeit from elevated levels), August factory hours worked edged lower, and mining output probably dropped.”
- Consumer Price Index (Tues): Economists estimate CPI fell 0.1% month-over-month in August, while climbing 0.2% on a year-over-year basis. Excluding food and energy, core CPI is estimated to have climbed by 0.1% and 1.9%, respectively. From Credit Suisse: “We expect a 0.1% mum decline in headline CPI, which would be the first monthly drop since January. Falling gasoline prices should be the main story for headline, with nationwide average prices down 23 cents in August versus July, in a month where seasonal factors are expecting an increase in gasoline prices. Our core forecast is 0.2%, with a widening divide under the surface between relatively firm core services inflation (driven mainly by shelter) and weak core goods (pressured by falling import prices).”
- NAHB Housing Market Index (Tues): Economists estimate this index of homebuilder sentiment was unchanged at 61 in August. Here’s Bank of America Merrill Lynch: “We suspect that the financial market turmoil over the past several weeks and concern about the Fed’s hiking cycle will weigh on homebuilder sentiment. However, the fundamentals of the housing market remain strong with recent data showing low inventory and greater buyer interest.”
- Initial Jobless Claims (Thurs): Economists estimate initial claims climbed to 277,000 from 275,000 a week ago.
- Housing Starts (Thurs): Economists estimate the pace of starts fell 3.0% to 1.17 million units while the pace of building permits climbed 2.2% to 1.15 million units. From Bank of America Merrill Lynch: “Much of the volatility recently has owed to multifamily building which surged in the Northeast in early summer due to the timing of a tax assessment. This reversed in July with a sharp drop in multifamily starts. However, single family starts were up sharply in July, increasing 12.8% mum SA. This brings single family starts above permits, suggesting starts will likely revert back in August.’
- Philadelphia Fed Business Outlook (Thurs): Economists estimate this regional activity index slipped to 6.0 in September from 8.3 in August. Here’s Barclays: “New orders have fallen for the past three months indicating stagnant demand. Shipments rose to 16.7 in August, but we see some downside to this measure of output in September. In line with tepid employment and output growth for the manufacturing sector overall, we expect the Philly Fed index to remain at modest levels over the next several months.”
- FOMC Announcement (Thurs): The Fed will conclude its 2-day Federal Open Market Committee (FOMC) at 2:00 p.m. ET. The consensus is call of the fed funds rate target range to be unchanged at 0.0.%-0.25%.
Veteran stock market strategist Rich Bernstein believes we’re in the early phases of a long-term, secular bull market.
But he also notes that secular bull markets come with bumps. And he attributes some of the recent bumpiness in the markets to the expectation for a September rate hike from the Fed as corporate earnings growth turns negative.
“This chart shows how unusual the past several years have been because the Fed did not raise rates as the profits cycle accelerated,” Bernstein wrote. “The Fed now risks being wrong footed, and the problem for the stock market today is the Fed is ‘threatening’ to raise interest rates at a time when S&P 500 earnings growth is actually negative. We’ve been concerned for many months that the recipe for the much- anticipated correction could be the Fed hiking rates when earnings growth was negative.”
Bernstein suggested that the stock market could better weather any pressure if the Fed held off for a little bit.
“If the Fed pushed off raising rates until December or early next year and the profits cycle reaccelerated by that time, then the tightening cycle would seem more normal,” he said.
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