World’s attention turns to Fed rates outlook

THE US Federal Reserve’s two-day policy meeting is the main event for financial markets this week.

THE US Federal Reserve’s two-day policy meeting is the main event for financial markets this week and, while economists don’t expect any fireworks, the Fed’s statement early Thursday Australian time will be closely watched for any fresh insights into monetary policy.

There will be no press conference this month, and economic and interest rate projections won’t be updated until the December meeting, but financial markets nevertheless expect a slightly dovish tone to the Fed’s policy statement because of the recent spike in volatility and risk aversion, together with lower than expected US inflation and a sharp decline in oil prices.

Global equities went into a tailspin earlier this month after minutes from the Fed’s September meeting said some Federal Open Market Committee officials expressed concern that persistent economic weakness and deflation in the eurozone could hurt US exporters by pushing up the US dollar, and that slower economic growth in China or Japan, or unanticipated events in the Middle East or Ukraine, might have a similar effect.

Although the September Fed minutes acknowledged that there was still significant under-utilisation of labour resources and that a rising US dollar could slow a gradual rise in inflation towards the 2 per cent target, financial markets didn’t immediately embrace the implied message that interest rates could stay lower for longer as a result.

Australia’s sharemarket hit an eight-month low after the minutes triggered heightened risk aversion in global markets. But after falling as much as 10 per cent from its August high, the benchmark S&P/ASX 200 subsequently recovered more than 6 per cent.

Soothing words from various Fed officials subsequently helped global equities recover. Most notable were comments from St Louis Fed president James Bullard, that if something “more serious” happens to the US economy, the Fed would have an option of “ramping up” its latest money-printing program that’s on track to end this month.

That’s not new — the Fed has long said that quantitative easing could be used as an ongoing tool of monetary policy — but it would be a big step to deviate from the current tapering of QE.

With financial markets having recovered in the past two weeks, the Fed is widely expected to reduce its bond-buying to zero and reiterate that it will be appropriate to keep interest rates near zero for a “considerable time” after its asset purchase program ends.

The consensus is for US rates to rise in mid-2015, and in the dovish camp, Boston Fed president Eric Rosengren has said he could “easily imagine” a scenario where the Fed keeps rates near zero until 2016.

The main question for economists is whether the Fed gives any additional emphasis to economic slack and disinflationary pressures that could lead them to keep interest rates low for longer.

“On balance, the fall in the oil price, the rise in the US dollar, global deflationary worries and sub-par global growth will have the effect of reducing inflationary pressures in the US,” says Shane Oliver, head of investment strategy and chief economist at AMP Capital. “You would expect the Fed to emphasise falling inflation expectations and labour market slack. They may even say that even though they’ve ended QE, they reserve the right to increase it again if inflation expectations continue to fall. Whichever way you cut it, I think the statement to be relatively dovish.”

Of course, any change to a more dovish tack by the Fed may not be clear until it releases the monetary policy projections of its members in December.

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