Fed says rate hike next month hinges on market volatility

Reuters: The Federal Reserve on Friday left the door open to a September interest rate hike even while several US central bank officials acknowledged that turmoil in financial markets, if prolonged, could delay the first policy tightening in nearly a decade.

Some top policymakers, including Fed Vice Chairman Stanley Fischer, said recent volatility in global markets could quickly ease and possibly pave the way for the US rate hike, for which investors, governments and central banks around the world are bracing.

With a key policy meeting set for Sept. 16-17, at least five Fed officials spoke publicly in what amounted to a jockeying for position on whether increasing the Fed’s benchmark overnight lending rate was too risky amid an economic slowdown in China, a rising US dollar and falling commodity prices .

“It’s early to tell,” Fischer told CNBC on the sidelines of the annual central banking conference in Jackson Hole, Wyoming. “We’re still watching how it unfolds.”

He, along with other Fed officials, acknowledged that the global equities sell-off that began last week would influence the timing of a rate hike, which until only a couple of weeks ago seemed increasingly likely to occur in September.

Concerns about China’s economy have whipsawed markets, including Wall Street, even while US economic data has been robust. US stock indexes ended largely unchanged, capping a week that included both the market’s worst day in four years and biggest two-day gain since the 2007-2009 financial crisis.

“I think they could settle fairly quickly,” said Fischer, a close ally of Fed Chair Janet Yellen.

St. Louis Fed President James Bullard told Reuters he still favored hiking rates next month, though he added that his colleagues would be hesitant to do so if global markets continued to be volatile in mid-September.

The Fed’s policy committee “does not like to move right in the middle of a global financial storm,” Bullard, a Fed hawk, said in an interview. “So one of the advantages we have is that this storm is occurring now and, at least as of now, we think it will be settled down” by the September meeting.

The comments suggest the next two and a half weeks will be critical for the Fed as well as for global markets. A US rate hike is expected to hit emerging market equities and currencies particularly hard, adding to the sell-offs already seen.

The American economy, however, continues to shine despite longer-term concerns about low inflation.

The US government reported this week that the economy grew at a 3.7% annualised pace in the second quarter, sharply higher than its previous estimate, and that consumer spending, which accounts for more than two-thirds of economic activity, rose again in July.

Investors and economists have been betting the Fed would delay a policy tightening to December or later, prolonging the monetary stimulus that has kept rates at rock-bottom levels for more than six years and has pumped trillions of dollars into the global banking system.

But after Fischer spoke, traders added to bets that a rate hike would come this year, with overnight indexed swap rates implying a 35% chance the Fed would move in September and a 77% chance of a December move.

Atlanta Fed President Dennis Lockhart, a centrist who has become less resolute about a September rate hike as markets have tumbled, told Bloomberg TV that it was reasonable to see the odds of a move next month as roughly even.

One idea appearing to gain ground on Friday hinged on the Fed raising rates once or twice and then holding off until inflation started to rise to its 2% target. A strong dollar and lower oil prices have kept a lid on prices despite an unemployment rate that is close to normal at 5.3 percent.

Bullard told Reuters the Fed could hike rates once then “hang out” at that level if inflation remains too low.

Cleveland Fed President Loretta Mester, another so-called hawk who, like Bullard, sometimes runs against the grain at the central bank, said the economy still could handle a modest rate hike, though she did not commit to backing a move next month.