So after all the speculation, after all the waiting, the members of the Open Market Committee stared across the gap and decided to pause, to have a think if you will, before leaping into a future where America tried to move monetary policy on from the global financial crisis to a more normal setting. The pleas of the IMF, World Bank, top bankers and others have clearly been listened to. For now there is no interest rate rise, the Federal Funds rate remains set a 0 – 0.25%, possibly for the rest of 2015, despite Ms Yellen’s earlier determination to see a start to normalisation in 2015. The uncertainties surrounding the slowdown in China, the recent bout of market volatility, the fragility of the recovering US labour market were too much – in the considered view of the committee – to justify a rate hike at the present time. One decision maker even thinks rates shouldn’t rise until at least 2017, but it’s clear that the consensus is moving towards an early 2016 rate rise.
Markets reacted gleefully to the announcement with the S&P 500 jumping more than 20 points initially but ending up slightly down on the day as all the ‘no hike’ bets were taken off at a profit. Similarly in the currency markets the dollar sold off sharply into the news, but the markets have been less quick to take off the winning bets as is clear looking at EUR/USD and USD/JPY. The greenback is considerably weaker against peers than it was this time yesterday.
I do have some sympathy with the view that a rate rise yesterday could have sparked a 1994 style bond market meltdown. Then the results of Federal Reserve hawkishness precipitated the so called ‘Tequila crisis’ and near financial collapse for Mexico. In this case who knows which economies would have played the role of victim, perhaps sitting down at the FOMC, a decision maker might have theorised that China could somehow be in line for the starring role, no one can criticise pulling back from the brink if that was the case! China, after all, is NOT Mexico. It is now the 2nd largest economy in the world (or 1st if some PPP measures are to be believed), and if the Tequila crisis brought some of the largest US banks to their knees, goodness knows what the cascading effect of a Chinese collapse would have done to the global economy. No.. in retrospect perhaps caution was the wisest course. As you all know from my blog yesterday I was fully in support of the need for a hike, and I’m not backing off, but I can empathise with the decision if those were the risks that were considered. I still believe that we live in a world where there is an asymmetry in the monetary decision making process, if inflation is temporarily low it can be used as a justification for keeping interest rates lower than they should be, yet if inflation is temporarily high central banks will “look through” the data and justify holding rates lower for longer. Interest rates are equivalent to the cost of money in my view, it is a hugely important variable in a capitalist system. I fear that investment decisions are being made now at distorted cost levels and we will all pay in the long term for the understandable misjudgements. It is a judgement call that relies on avoiding the pain now, but potentially storing up something considerably worse in all our futures.
For now the currency markets will need to adjust to a new setting. There needs to be a reassessment of the determination of the Federal Reserve to normalise policy, if, as I expect, the market sees this as merely a pause then the dollar will begin to rally again. In this scenario I would expect GBP to underperform USD, EUR and JPY. After all whither goes the decision of the Federal Reserve, so goes the Bank of England.
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