Last Thursday, the Federal Reserve, the US central bank, announced what may have been the most keenly awaited interest-rate announcement since the crisis. Following recent upheaval in the markets, investors had gone from expecting a small rise to anticipating a freeze – but accompanied by a warning that rates would still be rising soon. So when the Fed maintained the Federal Funds rate at the existing 0%-0.25% level, few were surprised. What did startle markets was the “dovish” tone of the official statement and press conference that followed.
The timing of future rate rises will depend on “progress – both realised and expected – toward [the Fed’s] objectives of maximum employment and 2% inflation”. But Fed chief Janet Yellen also noted that the rising US dollar had already tightened US financial market conditions. The Fed also said it would pay attention to “the outlook abroad”, a reference to the collapse of the Chinese stockmarket over the summer, and a drop in commodity prices.
Stocks wobble
If the Fed hoped to calm markets, it was soon disappointed. Both US and European equity markets fell by around 2% on Friday, and have continued to struggle this week. Investment banks – which were expected to benefit from a rising interest-rate cycle boosting their profit margins – were particularly hard hit. Energy prices fell slightly, with fears over global growth outweighing the benefits of lower rates. Emerging markets were unimpressed by the decision too.
Indeed, officials from both China’s and Indonesia’s central banks criticised the Fed for being unclear about its strategy, with a Chinese official saying that “central banks should be responsible and provide better guidance to the market”. Part of the problem was the reference to external conditions. As well as its employment and inflation targets, the Fed has introduced a “quasi-third mandate” on global growth, says Jeremy Zirin, chief equity strategist at UBS Wealth Management, on Reuters.
Fed officials are “fooling themselves into thinking that, if they only just wait a little longer, all the uncertainty will clear up and they can raise interest rates with no danger of making a mistake”, said Paul Ashworth of Capital Economics. “The real world doesn’t work like that… there is always considerable uncertainty.” Ashworth still expects a December hike, but “it’s possible” the Fed “will find another reason to wait until early 2016”. But the longer the delay now, “the higher interest rates will eventually have to go”.
The Fed should be more bold
Yet it’s no surprise Yellen failed to raise rates, says Edward Luce in the Financial Times. “The damage to the Fed’s reputation would pale against its loss of face were it to raise rates only to reverse itself thereafter.” In any case, she was right – America “shows few signs of overheating”. That said, “every emerging-market tremor will boost speculation of another delay in December”. As a result, Yellen “needs to spell out what will guide her decision before then”. This “lack of guidance and transparency” is what has investors rattled, agrees The Guardian’s Suzanne McGee. Indeed, Yellen seems to have moved away from providing forward guidance altogether, which means we’ll see another bout of Fed-mania before December’s meeting.
The Fed’s influence means it does have to “balance both domestic and global factors”, says demographics expert and UBS adviser George Magnus, also in the FT. But China’s economic adjustment is no short-term thing – it will take years. The Fed can’t keep delaying on that basis, particularly if the US continues to recover – it’ll only result in a “more disruptive policy adjustment” in the future. “The Fed should start telling markets about the difficult trade-offs it faces.”