US Fed Notes Lower Risks to Economy, Leaves Rates Unchanged

As the Federal Reserve left its base interest rates unchanged, having highlighted the reduced risks of a recession, market volatility or economic collateral; market participants now expect interest rate hikes to occur no earlier than 2017.

Kristian Rouz – Following its Federal Open Market Committee (FOMC) meeting, the US Federal Reserve announced they would leave base interest rates at their current 0.25-0.5 percent level with possible increases coming up as the risks to the broader economy have “diminished”, apparently referring to the recent gains in the labor market. Their move supported the view of an anticipated acceleration in underlying inflation.

However, as commodities prices are poised to fall again, lower fuel and material costs could start taking their toll on the US domestic prices index. Therefore, the prospects of further hikes in rates remain unclear, thus having little effect on the market participants’ view of the policy.

The Fed left interest rates unchanged, extending the loose monetary conditions and affordable credit era till at least September, thus contributing to the “last call for credit” rush amongst investors. Albeit the US macroeconomic conditions, in the Fed’s view, are becoming more favorable for the planned and ongoing tightening cycle, the risk-avert regulator would only monitor the incoming data without undertaking major policy moves.

“Near-term risks to the economic outlook have diminished,” a FOMC statement released on Wednesday read. Following their two-day meeting in Washington, the policymakers reiterated their commitment to “closely monitor” core prices index dynamics and potential international headwinds. The regulator referred to the job market situation as having been “strong” last month, pointing "to some increase in labor utilization in recent months.”

The Fed has been putting off a planned rate hike since December, when the benchmark borrowing costs were raised from near-zero to their current level of 0.25-0.5 percent. Prior to that, the last rate hike occurred in 2006, when the economy was mired in the subprime abyss. This time, however, most of the Fed’s wording was quite similar to what they said after their June policy meeting. Therefore, a September hike is still unlikely, while a November increase will probably be ruled out due to the elections. The December meeting remains the only feasible option this year.

"It sounded a reasonably upbeat tone, not a big difference from last time, but a reasonably upbeat tone," Kathy Jones of the wealth manager Charles Schwab and Co. said.

According to the Fed’s projections, inflation is expected to advance beyond his current level of an annualized 1.6 percent. For over the past four years, US inflation has fallen well below the Fed’s targeted 2 percent threshold, indicating a “normal” pace of prices gains.

The dismal job market situation in May, Brexit in June, lingering international headwinds and commodity market volatility, along with the dollar's strength affecting US corporate earnings and domestic manufacturing have all rendered the Fed cautious regarding further hikes. The policymakers’ agenda is changing gradually, yet, it might take a while before the next raise in rates occurs.

"It’s kind of an upbeat statement, although guarded," Roberto Perli of Washington-based Cornerstone Macro LLC said. “It’s a sign of a little bit of confidence, if you want, in the outlook going forward."

The FOMC observed that household spending has increased, while business investment has been rather weak recently, also having noted that overall economic activity remains moderate. The Fed might raise rates in September on the back of very solid macro data, yet, given the renewed decline in commodities and the capital build-up in haven assets, this isn't a particularly viable perspective.

Meanwhile, one of the Fed board members, Esther George, President of the Kansas City Federal Reserve Bank, insisted on a 0.25 hike to be undertaken this time, reflecting the view that the extended period of loose monetary conditions is hurting the overall economy.

Federal fund futures, meanwhile, suggest a 50 percent chance of a hike before the year’s end. Yellen in scheduled to deliver a speech at the Kansas City Fed on 26 August, suggesting there is widespread anxiety brewing in the struggling US regions, including the Midwest, over the loose monetary conditions, suggesting that a new asset bubble is brewing, hampering Main Street investment.