Once again, the US Federal Reserve is about to make a historic interest-rate decision against a backdrop of rising equity volatility, tumbling commodity prices and jitters in credit markets. This time, investors expect policy makers to pull the trigger.
Fed Chair Janet Yellen has been preparing financial markets for a rates liftoff this week as evidence grows that the US economy is strong enough to weather tighter monetary policy.
Many market watchers were taken by surprise when the Fed held off at their September meeting, even in the wake of the first correction in the Standard & Poor’s 500 Index in four years.
If Fed officials “don’t do it this time, they’ll look stupid,” Citigroup Inc Hong Kong-based strategist Ken Peng (彭墾) said. “The things that are causing the market to behave this way aren’t going to be resolved if they hold off another month or two.”
In the lead-up to the Wednesday’s decision, investors are contending with crude below US$36 per barrel, stress in the US junk-debt market and the longest streak of losses in global equities since August. While the financial turmoil spurred by China’s yuan devaluation that month stayed the Fed’s hand in September, policymakers have since signaled increasing determination to go ahead with the first rate increase since 2006.
The prospect of higher borrowing costs has helped erase US$2.5 trillion from global equities since Dec. 1, and stock swings have widened. The Chicago Board Options Exchange Volatility Index has climbed more than 50 percent since the start of the month to 24.39, the highest level since Sept. 30. In the weeks preceding the September meeting, the index was in the process of retreating from 40.74, its highest in almost four years.
Asian stocks extended their biggest weekly decline since September yesterday, sliding 1.4 percent, and a gauge of global emerging equities tumbled toward a 2009 low.
“I don’t think the Fed will be overwhelmed by things like fund redemptions,” UBS Group AG Singapore-based regional chief investment officer Kelvin Tay said. “If they don’t raise, it acts as an overhang in the market and that will affect business and consumer sentiment. Everybody is just going to hold back. They should actually raise and get it out of the way so that everybody can get on with life.”
Traders are pricing in 74 percent odds the Fed plans to end the era of near-zero borrowing costs on Wednesday, down from 78 percent a week ago but higher than 72 percent at the beginning of the month. Before the September decision, futures showed about a one-in-three chance of an increase. One potential hurdle for higher US rates was cleared at the weekend as Chinese economic data for November came in better than economists projected.
BNP Paribas SA Tokyo-based interest-rate strategy head Tomohisa Fujiki is already looking past the decision this week. With little inflation in sight, a cloudy global outlook and the weakest US expansion in decades, there are not many reasons to compel the Fed to move quickly or aggressively, he said, adding that turmoil in markets might further moderate the central bank’s trajectory.
“The first rate hike is almost a done deal, but there’s more concern for the second rate hike or the third rate hike — if the Fed really can continue its rate-hike program in 2016,” he said. “That’s obviously what we have to watch.”
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