The day we’ve all been talking about for months has finally arrived and the mood going into it is fairly upbeat, although I do expect to see plenty of caution from traders as the day progresses.
All eyes around the investing world will be on the U.S. this evening as people eagerly await the decision from the FOMC on whether to embark on the first rate hiking cycle in almost a decade. This is the most highly anticipated Fed decisions in years and investors, analysts and economists everywhere are split on whether the central bank will raise interest rates this month.
The markets on the other hand seem pretty convinced, which is quite surprising given the repeated warnings from Fed Chair Janet Yellen that the intention is to raise rates this year. Markets are currently pricing in a less than 25% chance of a rate hike at today’s meeting which is quite surprising and leaves them open to quite a shock if the Fed does proceed as warned.
Source – CME FedWatch, based on CME Group 30-Day Fed Fund futures prices.
Of course, the data has not been perfect from the U.S. and inflation does remain stubbornly low, as calculated by the core personal consumption expenditure price index, the Fed’s preferred measure. That said, Yellen and others have repeatedly stressed that the central bank should not wait for inflation to go above 2% before raising rates as at this point, it will be too late and the future hikes would probably have to come thick and fast. This would be far more damaging than a small hike now and another in, say, 6 months.
While wage growth and spending remain relatively subdued, the labour market has tightened significantly and unemployment is at 5.1%. Wages are very likely to pick up under these circumstances and if we get a slight rebound in commodity prices at the same time then inflation could pick up very rapidly. This is effectively what the Fed is preparing for if it raises interest rates.
One of the biggest fears of an interest rate hike has been the emerging markets and what impact it would have on them. A number of central bankers from the emerging markets have recently been calling on the Fed to raise rates claiming the uncertainty is having a greater impact on them than the hike itself. Remove the uncertainty and markets will find their feet. The latest to join this group was Reserve Bank of India Governor Raghuram Rajan who claimed that “It’s preferable to have a move early on and advertised, a slow move up rather than the Fed be forced to tighten more significantly down the line”.
While the FOMC decision is clearly the key focal point for markets today, it is worth pointing out that there are a few pieces of economic data also being released. U.K. retail sales will be released this morning which should be keenly watch and the Bank of England is another central bank considering rate hikes and yesterday’s jobs report will only have supported this.
Retail sales have been fairly strong in the U.K., the core reading last month was 4.3% on the year. This month it is expected to be slightly lower at 3.9% but this is still a very encouraging figure for a consumer driven economy like the U.K.. With wage growth also picking up nicely, I think we’ll see people bringing forward their rate hike expectations in the coming weeks. The BoE is arguably in a better place to raise interest rates than the Fed at the moment.
Housing starts and building permits data, U.S. jobless claims and the Philly Fed manufacturing survey will also be released in the U.S. this afternoon, although the reaction to these may be smaller than normal given what follows just hours after.
For a look at all of today’s economic events, check out our economic calendar.