US: December hike is looking much more likely - ING

Rob Carnell, Chief International Economist at ING, notes that the US Federal Reserve left rates unchanged yesterday but said that “case for an increase in the Federal funds rate has strengthened” – and three members dissent, preferring a 25bp hike which suggests that a December hike is looking much more likely.

Key Quotes

“The Fed left rates unchanged at its September meeting. But the statement of the meeting gave the clearest indication yet that rates will soon rise. Once again, however, the Fed decided to wait for more information before hiking.

We think a December rate hike is the Fed’s current intention, though they still have to get through the Presidential Election on 8 November, and that could yet lead them to delay again if markets weaken on the outcome. So while the evidence is mounting for a December hike, we are going to wait until we know the outcome of the election before bringing forward our 1Q17 hike forecast.

The most important part of the Fed’s statement was the phrase, “The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives”.

This is unusually blunt for the Fed, but in addition, they revised up their assessment for the balance of risks to the economic outlook as “roughly balanced” – having noted at the July meeting merely that the downside risks had diminished. In the past, a “balanced risk” assessment has been an indication of an imminent rate hike, though we suspect that the proximity of the October meeting to the Presidential Election on 8 November, will make that effectively a “non-meeting”, leaving December by default, the last chance for a hike this year.

The statement also gave its language on the state of the economy an upward tweak, noting that it had “picked up”, it was previously growing only at a “modest rate”. The Fed also took an upbeat view on the labour market focussing on “solid” job gains, and dropping reference to labour utilisation, where their labour market conditions indicator has awkwardly fallen for seven out of the last eight months. There was no significant change to the Fed’s assessment of household spending or investment which remained respectively “strong” and “soft”.

The missing piece of the jigsaw puzzle for the Fed is inflation. But as we move towards the December FOMC meeting, base effects should lift this much more clearly towards their 2% goal. And unless anything else changes, a more rapidly rising rate of headline inflation will give the Fed a much more obvious reason to hike again in December.

From the dot diagram, it only looks as if the Fed has one more hike in mind for this year, as 10 of the 17 members anticipated the Fed funds rate range being 0.5-0.75% by the end of the year. As we get closer to the year-end, this diagram assumes greater importance in terms of the timing of hikes, and so it looks reasonably clear to us that the overwhelming majority of members are eyeing December very seriously.

There were few changes to the longer run view of Fed funds though. This only edged down to a median of 2.9% from 3.0%. We anticipate that in time, this will come down much closer to 2.0%. But this is an easy one for Fed members to take their time on, as the long run never actually comes…

Further evidence of how close this meeting came to an actual hike comes from the three dissenters, George, Mester and Rosengren, all of whom thought that rates should have been raised by 25bp at this meeting.

So a December hike looks extremely likely right now, barring the politics – but with the Presidential race looking closer and closer, there is still a chance of further delay.”