US Fed (In) decision

By Charles Stodart, Zurich Investment Specialist

The recent US Federal Reserve meeting last week has left investors both frustrated by the lack of clarity in the accompanying commentary and scratching their heads as to when the long-awaited hike in US interest rates will actually happen.

It wasn’t surprising that rates were left on hold, given that the chances of a hike had fallen to only 30%. But it was the cautious comments that accompanied the release which highlights the challenging mix of factors that Chair Yellen now has to consider.

In the US, economic activity is advancing at a moderate pace and there has been steady improvement in the unemployment rate. If the decision was purely a domestic one, the signs are there that the Fed is indeed close to hiking.

However, Chair Yellen has given more weight to the ‘uncertain outlook abroad’. One thing that has changed since rates were last raised in 2006 has been the growing importance of China. Nine years ago, China’s economy ranked fourth, just ahead of the UK. Today, China is a clear second and is twice as big as third-placed Japan. China appears to have become too big to ignore, especially given her recent growth stumbles.

Chair Yellen is particularly mindful of deflation, influenced in part by China’s devaluation in the Yuan in August. In fact, inflation expectations in the US for 2015 were cut from a low 0.7% to a mere 0.4%. The US Fed doesn’t expect inflation to hit their 2% target until 2018. On this basis, there’s merit to the caution.

While emerging markets stability is again in the spotlight, we think the threat of a spillover into the US and the growing levels of pessimism in general is probably overstated but does warrant caution.

Either way, the lack of clarity will keep markets jittery for the foreseeable future.

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