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Fed: China prolongs the endless wait

With the world's spotlights trained on them, FOMC members chose to keep key interest rates unchanged. This summer's events got the best of the impetus to raise key interest rates (note that for the first time, one member, Jeffrey Lacker, voted for a 25 bp raise in the fed funds rate), although it had been discussed during the meeting. Strangely, this episode recalls September 2013, when many observers were expecting the QE tapering (a slowdown in securities purchases by the Fed) but the FOMC ultimately chose to wait until December to begin.

Why wait? There is no shortage of reasons to put off tightening fed funds: businesses are still reluctant to invest or raise wages, the participation rate is still low, involuntary part-time work is still high, and financial stress indicators are climbing inexorably. Above all, concerns about the Chinese economy are more intense than ever. That is the primary factor offered up by Janet Yellen to explain the status quo: though she does not say it could weigh heavily on US economic activity, she does stress that it will put added weight on inflation, which is still extremely low (as are inflation expectations). So the Fed shares the concerns aired by the ECB two weeks earlier, and could even provoke a reaction by the ECB with the euro's appreciation against the dollar.

And by lowering its long-term growth forecast yet again, to 2% (close to the 1.7% assumption made by the Fed’s economic staff, released some weeks ago), FOMC members show that they buy into the secular stagnation scenario. FOMC members feel that growth will scarcely exceed 2% in the years to come. Further-more, they are setting break-even unemployment a little lower than before.

What value should the dots be given? For the fourth time in a row, FOMC members lowered their fed fund projections (dots) for 2017 and long-term. The dots are forever converging toward market anticipations, and they will probably continue to fall with regard to 2016, 2017 and 2018. It is true that a rise in fed funds in 2015 cannot be ruled out, but now it cannot be denied that the fed fund cycle will be limited in scope. Is it really reasonable to consider fed funds at more than 2.50% at end-2017? Why would the Fed toughen its rate policy so much when it foresees only weak growth, a very slow rise in inflation, and China with even weaker growth in the years to come?

This bolsters the idea that US long-term rates will stay relatively low. Further-more, in the short term, the delay of fed fund tightening also gives the dollar some breathing room, so it could stabilise for a while after gaining nearly 15% in real effective terms since the summer of 2014. More than ever, China is now dragging down the principal market trends.

 

2015-09-18-Focus
DRUT Bastien , Strategy and Economic Research at Amundi
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Fed: China prolongs the endless wait
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