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Is it about to or has it already happened? Federal Reserve loss of credibility

By 25th November 2015 News No Comments

yellen

As we know, December is the favoured month the Federal Reserve begins lift off and hikes interest rates for the first time since 2006, unless an unprecedented catastrophe in the employment figures occurs. If the Fed postpone hiking again, they will lose credibility for sure, but has this already happened?
The arguments for the Fed to hike the Federal Funds Rate outweigh all other moves in monetary policy movements, however markets have already priced in an initial hike and nothing further or reversal and cut rates soon after the first hike.

Why?

Economic growth is the US is still low, yes the unemployment rate at jobs market is back on track and improving. Nonetheless a “lower for longer” policy leads to a substantial amount of debt build up in the economy. If total debt is 300% of GDP across the economy, an interest base rate at 1% would use 100% of GDP to service it, therefore already capping the Fed on further rate hikes after the liftoff. Essentially this means the economy can’t handle a higher interest rate with the current levels of debt in the economy.

What does this mean for the Federal Reserve?

If the Federal Reserve hike and cut, they will lose all credibility instantly. Some would argue this has already happened. The September meeting was favoured the 2015 month for liftoff, however the meeting concluded the Fed was looking at market conditions, raised its international awareness and the effects of the China slowdown, but in the previous minutes from the last meeting there was no mention of this and the sentences were dropped suggesting the Fed is stalling.

Market Reactions

The markets aren’t currently pricing in a sustained hike, or further hikes from the Fed due to nature of the level of debt and the lack of economic growth.
This is evident in the bond markets with the yield curve flattening quickly. If we look at the 3M Eurodollar futures quotes, the March 2016/2017 contracts spread is a just over 60 basis points, suggesting maybe 2 hikes next year and that’s it from the Fed. It’s very apparent the bond and futures markets don’t believe the Fed can hike and sustain at that level.

EURUSD currently trading at 1.0636

USDJPY currently trading at 123.05