Hold onto your bootstraps. Markets are setting themselves up for a surprise as the Fed is still likely to hike rates in September. Today’s ‘risk-on’ move is a function of those expecting delay. Rising levels of market volatility are here to stay and will be magnified by this ‘surprise’. Those ignoring the warnings of a rate hike by Fed officials do so at their own peril.
Many FOMC members have said that they expect ‘bumpiness’ when they raise rates for the first time in nine years. They probably believe recent market volatility is partially explained by the fact that the September FOMC meeting is approaching and some investors were preparing themselves.
The Fed has adequately prepared the market for a hike. Delaying the hike once again would cause harm to financial markets. It would not be healthy to price out a hike completely, only to have to price it in again at a later date. Confidence would be damaged.
Moreover, I do not believe the Fed will opt to wait until the December meeting, because it would cause year-end balance sheet and liquidity issues that it would prefer to avoid. Waiting until 2016, also has its draw-backs, due to over $200 billion in Treasury securities set to mature. ‘One and done’ is more of a possibility to me than a delay.
The Chinese slowdown and troubles in emerging market countries is unlikely to prevent a hikebecause those countries are taking their own set of actions to confront their respective challenges. As the owner of the world’s reserve currency, the Fed must show leadership and be the first major central bank to move.
Unfortunately, this morning’s euphoria in US markets was partially due to the combination of many economists pushing out their expectations of the first rate hike until 2016 (some believe 2017), and partially due to China cutting rates. If they are correct, then financial conditions must deteriorate materially.
This post was published at Zero Hedge on 08/25/2015.