5 Reasons the Fed is Unlikely to Raise Rates in SeptemberLearn more about this firm
Central banks step back
Last week ended with a big drop for stocks, a significant pickup in Treasury yields and heightened volatility as investors began to fear that central banks would not continue with their high level of accommodation. First came Thursday's decision by the European Central Bank (ECB) to leave its current monetary policy unchanged. There would be no reduction in interest rates or an increase in bond purchases at this ECB meeting, as some had anticipated.
For the most part, investors held it together on Thursday. But then on Friday, having digested the ECB decision, they reacted more dramatically. They also seemed to be rattled by comments from Boston Fed President Eric Rosengren, considered by most to be a more dovish member of the Fed. Rosengren has become more hawkish as of late, noting that "a failure to continue on the path of gradual removal of accommodation could shorten, rather than lengthen, the duration of this recovery."
Where's the proof?
At the end of last week, even fed funds futures showed an increase in expectations of a Fed rate hike in September. However, I can't help but refer back to the "clear and convincing evidence" standard I mentioned in last week's commentary, as it doesn't seem that there is enough compelling data to cause the Fed to move in September. It's not that the economy is doing poorly, it's just that the economic data is not compelling enough. Perhaps Dallas Fed President Robert Kaplan said it best in an interview last week "we have the ability to be patient."
With that in mind, here are five key reasons why we don't think the Fed will raise rates at this month's FOMC meeting:
- Slower jobs growth. The August employment situation report was unimpressive and broke with the trend of robust job growth we saw in June and July. While the August jobs report does show improvement in the economy, it is a slow improvement that seems unlikely to give the Fed a sense of urgency about raising rates in September.
- Weaker labor market. Ditto for the Labor Market Conditions Index (LMCI), a holistic measure of job market health which Janet Yellen has referenced on occasion. The LMCI fell back into negative territory at 0.7, where it had been for the six consecutive months prior to the July meeting. While this is not terrible, it is arguably not the kind of reading that would compel the Fed to act this month.
- Manufacturing sector weakness. The August ISM Manufacturing Index fell into contraction territory for the first time since February. This was a significant decline from the previous month and was due to a major drop in new orders. While the ISM surveys in August are often ignored because August is an unusual month when many take vacation time and factories are sometimes shut down for a period, this disappointing reading could give the Fed pause. FOMC participants may want to wait and see what the next few months' ISM Manufacturing Surveys show before acting.
- Service sector weakness. The ISM Non-Manufacturing Index fell significantly in August to a level it has not seen in more than six years. New orders also fell precipitously in this reading, suggesting weakness will continue in the near future. The service sector has been very strong, so a one-month drop like this could be an aberration, especially considering the time of year. However, it seems likely the Fed would wait and see to be sure.
- Tame inflation. Inflation remains tame—despite signs of wage growth in the most recent Beige Book—and certainly does not place any urgency on the Fed to act at this time. However, we will be getting new inflation readings at the end of this week that we'll want to follow closely.
What central banks hath wrought
What is more important than whether the Fed acts in September is that investors need to recognize that central banks, through their extraordinarily unconventional monetary policy of the past few years, have created a dependence on them that is unhealthy for investors. We got a taste of it last week, but there's likely far more to come. Central banks and their financially repressive policies still play an outsized role in shaping the investment landscape.
Investors should expect central banks to remain "behind the curve," keeping rates lower for longer in order to provide support to economies. This means investors need to take risk in an attempt to generate adequate returns and income. Selective and geographically-diversified exposure to equities, particularly dividend-paying stocks, offer the potential for decent risk-adjusted returns. Emerging market debt, Asian debt and US high-yield bonds all offer attractive income solutions. But investors also need to prepare for a higher-volatility environment in this data-dependent world, using tools such as options to protect on the downside.
About the Author
Kristina Hooper is the US Investment Strategist and Head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law, a master's degree from Cornell University and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.
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