The Federal Reserve (Fed) left interest rates unchanged at the September meeting, citing recent global economic and financial developments that could restrain US economic activity and put further downward pressure on inflation.
Below, we discuss six initial takeaways regarding the Fed’s decision:
- We view the Fed’s statement as dovish, lowering the odds of a rate hike in the near-term. The Fed focused on potential negative effects of global economic and market developments, and lowered its inflation forecasts. We view this as a dovish statement that potentially lowers the probability of a rate hike in the near-term. The market is pricing in roughly a 20% probability of a rate hike at the October meeting and a 50% probability of a hike by the December meeting, based on Fed Fund futures data as of 9/17.[1] The timing will depend on developments in financial conditions and economic data, but we believe an October rate hike is now unlikely and the December meeting is a toss-up. We think this could dampen market volatility in the near-term, though uncertainty about Fed policy could lead to more volatility as the December meeting approaches.
- The path of Fed policy matters more than the timing of the first hike. We believe the US economy can support modestly higher rates and many of the business leaders we speak to would prefer some normalization of rates. As a result, we think the timing of the first rate hike is less important than how far, and how fast, the Fed ultimately raises rates. At Thursday’s meeting, the Fed lowered its projections for future rate hikes, signaling that the path is likely to be shallow and gradual. However, markets may become concerned that delaying the start of rate hikes could ultimately require the Fed to move more aggressively later.
- Lower for longer? The Fed lowered its long-run projection for the short-term Fed funds rate to 3.5% from 3.8% in June. This brings the Fed’s projection into closer alignment with long-term market rates. However, with 30-year Treasury yields around 3%, further convergence seems likely. Whether this means higher rates in the bond market or continued downward revisions to the Fed’s long-run policy rate projection will likely depend on trends in inflation expectations and wages.
- We believe a pro-cyclical mindset is still warranted. Fed tightening, in our view, has largely been priced in to equity and corporate credit markets and the path of rate hikes is likely to be gradual. A decision to raise rates would be evidence of the Fed’s conviction in the economy’s positive trajectory, which we believe will be favorable for risk assets.
- Currency and commodity trends are likely to remain intact. The Fed’s decision to wait, in our view, could put downward pressure on the US Dollar, at least initially, but higher US yields could support the existing trend of Dollar strength, particularly versus Asian currencies. A stronger Dollar has historically acted as a headwind for US multinational companies, but has also benefited US consumer purchasing power, and has pressured oil and other commodity prices. Commodities may rally if the Dollar weakens, although we believe only temporarily. With excess crude oil supply and weaker Chinese demand, we think the commodity price downtrend is largely independent of Fed policy, with few prospects of a reversal.
- In emerging markets, we think commodity prices, Chinese growth and local fundamentals are more important than Fed policy. The Fed’s eventual tightening (all else unchanged) has been well telegraphed and we believe emerging market assets have largely adjusted to the likelihood of modest rate hikes in the US. As a result, we continue to believe emerging market assets will be driven primarily by local fundamentals.
