The Federal Open Market Committee meets this week and while most don’t expect a rate change, they are expecting signals about how the Fed views the developments in China and the oil market, as well as any concerns that the US may slip into recession.
By Vikram Rangala
Monday, January 25, 2016
It’s much simpler to say what the Fed isunlikely to do:
It’s unlikely to raise rates again, just a month after the first increase in seven years. The Fed has signaled that it may do four rate hikes this year and gave no indication it was in a hurry.
It’s also unlikely to cut rates back to zero, since that would be a complete course reversal and a sign of something close to panic. Even a hint that they considered abandoning further rate hikes down the line would make investors and other central banks nervous.
Taking the most likely scenario, that the Fed will maintain the status quo, what else will they do? For the most part, they will have a wide-ranging discussion, the full minutes of which will only come out in a few weeks. And they will draft a statement designed to calm investors while addressing the numerous challenges both markets and individuals are facing.
When it raised rates in December, the Fed was aware that closing off the flow of zero-borrowing-cost money could tighten up capital spending by companies who would prefer to hold onto their cash reserves. Many have done so. Walmart is closing its 102 Express stores. Some companies, including big financials like JPMorgan Chase, have announced layoffs.
The rate increase also tipped some high-risk bonds into outright junk status, a problem made worse by the downgrading of some bonds issued by troubled shale oil and other energy companies. Those bonds seemed less risky when crude was above the shale oil break-even cost of $60-70. Now, they look more like the credit default swaps issued on rebundled subprime mortgages: bad bets on assets that some believed could never lose value.
However, unemployment remains low and some new developments have made the Fed’s stated goal of higher wages look more likely. Walmart announced across-the-board wage increases, with Senior Associates getting $15 an hour. When Wal-Mart raised its minimum wage to $9 last year, competitors like Target followed suit. This time, the ripple effect could be massive.
What the Fed did not anticipate in December was the extent of the weakness in China and the crude oil market. It also could not foresee the markets’ reaction to those events. The US stock market at its January 20 low came within 5% of what most economists consider a bear market. However, it isn’t there yet and multiple factors, particularly the unprecedented 70 months of job creation, give hope that the US will not fall into recession.
The unexpected series of what now look like blunders by China’s central bank, like the use of a faulty circuit-breaker mechanism that actually increased the selloff in China’s equity markets, is an example of what happens when large economies don’t work together. Europe and the US are by no means coordinating monetary policy. ECB President Mario Draghi has stated he is open to still more accommodation, something the Fed is unlikely to do. However, knowing what Europe was doing helped the Fed in its decision to wait until December to begin its rate hikes, just as having a decent sense of US sentiment helped the Eurozone move forward without fear of harming the global economy.
China’s moves have often come out of left field, surprising even Chinese banks and investors, leaving many to question whether President Xi Jinping has a coherent plan for China’s recovery, or at least a plan to keep China from roiling global markets while it gets its act together.
All of this turmoil will be on the Fed’s agenda, and committee members who expressed mild disagreement may be more open about their differences in the series of talks they give afterwards. But the statement itself will likely seek to calm investors and will use words like “cautious” and “observe” and the Fed’s new favorite, “data-driven.”
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