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Beverly Chandler

Roubini and ETF Securities cautiously predict December Fed hike

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The macroeconomic outlook from Roubini Global Economics and ETF Securities, this quarter, looks at potential outcomes of rising interest rates in the US. 

The firm believes that the December FOMC meeting is the likeliest time for the first Fed hike, but recognise there is a high risk of delay, depending on inflation performance and financial-market conditions.
 
If there are no new surprises, the firm writes that Fed officials have given ample notice that a 2015 rate hike is on the cards. “The September Summary of Economic Projections showed that 13 of 17 FOMC members expect to raise rates this year—a clear majority, even if that number dropped from 15 in July. Those forecasts were made in full knowledge of the current economic outlook and financial conditions, so, absent unexpected bad news, the FOMC will hike this year. Various Fed officials including Chair Janet Yellen are on the record favouring such a move.”
 
Arguments offered by Fed officials for hiking rates include: monetary policy involves long lags, so waiting to hike until inflation nears the 2 per cent target risks an overshoot; slamming on the brakes to regain control over inflation is more costly to the economy than starting early and moving gradually, and moving early means moving now; the Fed’s policy goals are nearly achieved, while the Fed is still in an extremely stimulative stance and easy monetary policy can induce asset bubbles, which can damage the economy when they collapse.
 
The firm writes that as Fed officials are not confident in macroprudential tools for dealing with bubbles, it is prudent to ‘lean against the wind’. “With doves losing the debate as it stands, a further delay in Fed rate hikes depends on new developments. The September FOMC statement and Fed chair Janet Yellen’s comments in her press conference both highlighted financial conditions and risks from overseas as key to the near-term policy outlook. Yellen also said deteriorating conditions outside the US make domestic labour-market performance more important to the Fed’s inflation goal.”
 
The firm lists conditions for delaying Fed rate hikes into 2016, including: unresolved problems in China create substantial risk of further trouble for the rest of the world; fragile emerging markets risk further capital flight, and weaker currencies and demand add to disinflationary pressures;  The US labour market may be cooling already, lessening its contribution to future inflation;  core inflation remains weak, with core PCE (the Fed’s preferred measure) well below core CPI;  an oil price plunge could push core PCE below 1 per cent (energy prices feed into services, such as airfares); higher-cost oil investment (shale, offshore) could slump;  further Dollar strength could lower the path of inflation and reduce domestic growth and budget and debt ceiling debates conjoin in December.
 
 
The approach of Fed hikes has already slowed, and even reversed capital inflows into emerging markets, the firm writes. “In aggregate, we see emerging-market currencies and the shorter end of the emerging-market curves as the asset classes most vulnerable to the rise in US rates, but country selection remains critical. Our Resilience to Fed Normalisation Indicator, which assesses the resiliency (or vulnerability) of different emerging markets to the Fed’s upcoming policy shift (and their ability to benefit from the strong U.S. demand that a Fed hike implies), shows substantial regional and cross-emerging-market divergence.”
 
Mexico and the Philippines display a higher capacity to cope with Fed hikes. India is the only country to have seen a meaningful increase in resilience since the “Taper Tantrum” in 2013. Brazil, Chile, Colombia and Indonesia all remain vulnerable to Fed hikes due to their domestic vulnerabilities. None of these countries have much scope to benefit from US demand either.
 
Key signposts to look out for, according to the firm, include: Inflation. The FOMC needs to be ‘reasonably confident’ it will achieve 2 per cent; unemployment. ‘Some further improvement’ is needed in the labour market. Given the recent weaker labour-market prints, this bar is rising and finally financial conditions. A hiking cycle with VIX>20, stocks dropping and credit spreads widening? Not very likely, the firm concludes.
 

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