- We now think the Fed will likely delay its first rate hike to 2016, given EM risks and softer macro data
- This makes additional ECB and BoJ easing even more likely, while the BoE will delay hiking to Q3
- EUR/USD will be in a range in Q4 as extra ECB QE offsets the scaling back of Fed hike expectations
Adjusting our Fed rate hike view
We now think that the Fed will further delay raising interest rates beyond December and into 2016. Uncertainty is high about the exact month, but our sense is that the first hike will not come until June 2016. We expect a rate hike every other meeting after that, which would leave the target for the fed funds rate in a range of 0.75-1% in December 2016. A delay will give the Fed time to allow financial conditions to stabilize, external uncertainties to wane and data to improve again. We don’t rule out a rate hike in March 2016 if this process turns out to run relatively quickly.
External headwinds a drag on the US economy
A stronger dollar and the slowdown in emerging markets, particularly in China has exposed some soft spots in the US economy. In the first half of the year, net trade has turned into a drag for the US economy and recent data has also shown a further widening of the trade deficit in the third quarter. Meanwhile, export-oriented manufacturing activity has been slowing in response to weaker foreign demand. Market tensions and a stronger dollar have combined over recent months to tighten financial conditions, meaning there is less need for an imminent rate hike.
US labour market takes a break
A couple of disappointing job market reports in August and September have marked a break from the past few quarters when the labour market recorded a solid performance. Indeed, a strong labour market has been one of the flagships for the majority of FOMC members supporting a rate hike this year. The diminishing slack in the labour market is expected to push up wages, but this may take a bit more time than we had expected. Moreover inflation pressures are still subdued. We think that these developments will make FOMC members more cautious.
More time to see economy stronger and external risks easing Indeed, we think the Fed will need more time to be sure that the US economy is ready for a rate hike. We think over time there will be signs that the Chinese authorities are managing to keep the slowdown in the economy gradual. This will also bring more stability to commodity markets and improve sentiment in emerging markets, helped by the Fed’s delay. This over time will likely boost US economic data.
Fed’s delay: a knock on effect to other central banks
If the FOMC does put the rate hike on ice as we expect, it will lead to reactions from other central banks. This is because all other things being equal, it will weaken the dollar and hence strengthen other currencies. For instance, the EUR/USD could surge to above 1.15, if there were to be a Fed delay, without any offsetting ECB action. The ECB is currently assuming a EUR/USD rate of 1.10. So we think this would add to the case for further easing against the background of the fall in commodity prices and the rise in EM risks over recent months. Our base scenario was already for an increase in the ECB’s monthly purchases by EUR 20bn. This looks likely to come in December rather than this month give recent ECB commentary. We now think that the ECB will also extend the time horizon for QE through the end of 2016. The risks of yet more decisive action have increased. Further QE by the ECB will offset the impact of the Fed delay, keeping EUR/USD at around 1.12 this year. Meanwhile, the BoJ will likely step up QE early next year, but the chances of an earlier move are now also much bigger. Finally, we are also pushing back our forecast for the first BoE hike to Q3 of next year, from Q1 previously. More analysis of the implications of all this for our FX, precious metals and fixed income calls will follow in additional notes later this week.