Markets Price in 21% Chance of September Rate Hike

By John Gallagher,   
International Business Editor

At the beginning of 2016, the Federal Reserve was ambitiously penciling in 4 quarter point rate hikes for 2016.

Yet after 5 meetings thus far in 2016, the Federal Open Market Committee has yet to raise the short term lending rate.  They have 3 meetings remaining this year, and market participants only see one rate hike in the horizon, likely in December.

So what happened this y-ear that has deterred the Fed from living up to their expectations of 4 rate hikes? Going back to June, the Fed was slated to raise short term rates by 25 basis points from 0.25 percent-0.5 percent to 0.5 percent0.75 percent.

Then a dismal May Jobs report was released, causing policymakers to question the strength of the labor market.  With lingering questions over labor market strength in the U.S., and the upcoming EU referendum in Great Britain, the Fed stood pat on interest rates.

Fast forward to June 23rd and Brexit shocked the markets creating a swath of uncertainty surrounding the economic impact Brexit would have on Great Britain and the European Union.

Despite an immediate selloff, global equity and credit markets bounced back after only 2 days of losses.

Following the weak jobs data in May and the surprise Brexit vote, all eyes were on the June jobs data to assess whether or not the weak May number was a fluke or signs of an ailing labor market. June’s jobs number shattered expectations and raised expectations of an increase in interest rates.

Stocks hit all-time highs, and the 10 year treasury yield which falls in times of market stress retreated back to 1.633 percent from 1.361 percent. Investors began to brace for potentially two 2016 rate hikes, one in September and one in December.

When Central Bankers met in Jackson Hole, Wyoming in August, Fed officials appeared ready to raise interest rates as soon as September.

Atlanta Fed President Dennis Lockhart told The Wall Street Journal “I, in no way, rule out September and look to December or look to even the November meeting” as possible times for a rate move.

After those comments, the markets expectations for a rate hike ticked up to 33 percent in September, but expectations for a hike were still low ahead of the August jobs report.

When the number came in at 151,000 jobs added, 29,000 below the consensus of 180,000, the markets re-calibrated and scaled back their expectations of a policy change to just 18 percent. Next, the ISM non-manufacturing index reading, which measures the strength of the service sector, came in far lower than expected at a reading of 51.4 percent, the lowest reading since 2010.

A reading of over 50 percent signifies that businesses are expanding, and a reading under 50 percent that business are contracting.

The good news is that service oriented businesses are still expanding, but the bad news is that it was a steep fall off from July’s reading of 55.5 percent and the last time the reading dropped below 50 percent, it signaled the start of the Great Recession.

The Federal Reserve has been very data dependent in their decision making process for when to raise rates and look economic data releases very closely to judge the strength of the economy.

When the economy is doing well, the Federal Reserve raises interest rates to keep inflation under control, and in times of contraction, they lower interest rates to spur lending in an effort to stimulate the economy.

The Federal Reserve meets next week on September 20-21 to make a decision on the Federal Funds rate.

Just 13.1 percent of the 61 economists surveyed by the Wall Street Journal expected the Fed to raise rates in September while 73.8 percent expected the central bank to wait until December to raise the Federal Funds Rate.

Fed Fund Futures currently indicate that the odds of a rate hike are at 21 percent, indicating that rates will likely stay the same.

As always, statements by Fed Chairwoman Janet Yellen will be closely analyzed by market participants for clues on future policy.

 

A version of this article appeared in the Tuesday, September 13th print edition.

Contact John at
john.gallagher1@student.shu.edu

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