Is the Fed ready to hike rates in December?

Last week saw the markets return to the main fundamental theme of monetary policy divergence. Just a few weeks after the ECB announced its intentions for further expanding the QE program at the December meeting, the Federal Reserve sent a hawkish message to the markets hinting at a rate hike in its ‘next meeting’ due in December, right after the ECB’s monetary policy meeting.

The hawkish message from the Fed came as the FOMC’s statement saw inclusion of new messaging, highlighting the direct tightening bias by noting that to consider whether it would be appropriate to rate the Fed funds rate at the next meeting, but also stating that the Fed would need to see further improvement in the labour markets to be reasonably confident that inflation will through to the Fed’s 2.0% inflation target rate.

The Fed’s statement could be seen as way to push the market pricing which was low ahead of the FOMC meeting while also aiming to build consensus among as many of the Fed members as possible.

From the 12 regional Federal Reserve Governor, eight proposed a 25bps rate hike in the discount rate while also signaling their intentions for a hike in the Fed funds rate, which was eventually put down.

Despite the risks of upward pressure on the US Dollar due to monetary policy easing from the European Central bank and the PBoC, the Fed felt quite comfortable shifting to a hawkish language in its statement, indicating that the Federal Reserve was looking at the financial conditions on a broader scale and not just the USD. The modest rally seen in the commodity and risk assets over the past few weeks has managed to offset the US Dollar’s strength and with positive demand from easier monetary policies globally, it was a more than welcomed by the Federal Reserve.

Right after the FOMC statement, the December rate hike probability, shifted from around 30% to 45% which still indicates that the markets expect to see the Fed hold rates in December.

The onus now shifts back to the US economy data which needs to convince the markets and the economists that the US economy will grow above its average trend next year while also inflation pressures will be closely watched. This week, the October jobs report will be one such report along with the ISM surveys which will provide ample ground for the markets to determine the probability of a rate hike in December. There is however a strong downside risk to the US manufacturing sector which is likely to suffer on account of a stronger USD and one which could potentially keep the Fed from hiking rates in December.

Fed Chair, Janet Yellen will also be speaking at two events ahead of the Fed meeting in December, which should provide enough opportunities for the Fed to convey its message to the markets. For the moment, the pricing in the futures market still implies that the market participants do not strongly expect the Fed to act in December, however this is likely to change as the economic data over the next two months unfold.