‘Super Thursday’ is finally here. Will the US Federal Reserve raise interest rates for the first time in over nine years?
The debate is still on within economists but the bond market thinks that a September liftoff is off the table. Futures forecast only a 20 percent probability that the Fed will raise interest rates on Thursday (September 17). The decision to tighten monetary policy should be temporarily delayed due to choppy global market conditions but there still remains considerable scope for a surprise decision which will lead to big moves in the market.
Below are the scenarios (both dovish and hawkish) which can play out:
1) No hike, but the committee signals the October meeting as ‘live’: this would be read as hawkish across asset classes with US yields and the greenback firming up strongly.
2)Twenty-five basis points hike, stating that fundamentals of the US economy suggest the timing of the liftoff is appropriate. The Fed acknowledges the slowdown and risks arising out of China and emerging markets but says it’s not enough to derail US economic growth momentum. This scenario is super hawkish as it opens up the possibility of another 25 basis points hike in December.
3)A dovish 25 basis points hike where the Fed clearly communicates that the timing of the next hike is a function of US data and global financial stability. This would reaffirm their data dependent monetary tightening path and send out a strong message that volatility in the global financial markets is something which they will consider going forward.
4)No rate hike but the committee conveys that it expects one later this year, again contingent upon domestic and global economic factors. This would again be read as dovish.
5)Fed is super dovish: strongly emphasizes the downside risks and headwinds to raising rates within the current economic outlook. This implies a rate hike in 2015 is off the table. This will most probably lead to a large rally in equities, unwinding long US dollar positions and US yields drastically cooling off.
Of the above, scenarios 3 and 4 are most likely. The risks of premature monetary tightening far outweigh those which would arise if the rates were raised 3-6 months down the line. Janet Yellen and her colleagues at the US Fed realize this better than anyone else. This column has long maintained that Yellen will undertake the loosest monetary tightening in financial history.
Stay calm and trust the Fed.
(Vatsal Srivastava is consulting editor with IANS. The views expressed are personal. He can be reached at firstname.lastname@example.org)