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US rates to remain on hold - but for how long?


The Fed has decided to leave interest rates on hold. More importantly, the commentary around the decision was relatively dovish.

Following the most anticipated and hotly debated US Federal Reserve (Fed) meeting in years, the Fed has decided to leave interest rates on hold. More importantly, the commentary around the decision was relatively dovish.

US rates to remain on hold

The case for the Fed to raise interest rates is well known: the US economy has been growing at around 2-2.5%; the labour market has strengthened with unemployment falling to 5.1%; and since inflation normally turns up with a lag after the jobs market there is an argument for the Fed to start hiking interest rates before that actually happens. As a result, a few months ago it was widely expected the Fed would move to start hiking at its September meeting.

In the interim, uncertainty about Chinese and emerging market growth has increased and inflation expectations have fallen. The Fed has responded to this by leaving interest rates on hold. This was in line with US fixed income market expectations that had only priced in a 30% chance of a hike at this meeting.

Fed’s commentary was relatively dovish

The clear message from the Fed is that is that it is aware of what is going on globally and is not going to do anything to threaten global growth at a time when US inflation is below target.

While interest rate expectations are still pointing to a rate hike this year, several Fed meeting participants have moved their view of the first hike into 2016 or 2017. In fact, one is now arguing for a rate cut into negative territory and the whole profile of Fed interest rate expectations is 0.25% lower.

The Fed is clearly conscious of the risks posed by recent global and financial developments surrounding China and the emerging world and the downside risks posed by this to US inflation.

When can we expect US rates to rise?

There was no recognition from the Fed that it is any closer to satisfying the conditions for a rate hike. While the Fed is likely comfortable that it has seen enough improvement regarding the jobs market, it still seems to lack confidence that inflation will move back to its 2% objective over the medium-term. This lack of confidence partly stems from the uncertainty regarding Chinese and emerging market growth, along with the impact of the stronger US dollar.

While Fed Chair Janet Yellen has indicated that the Fed’s October meeting remains “live” for a rate hike, it’s hard to see enough changing by then to justify lift-off. As such, December is more likely for a move but there is a reasonable risk that lift-off could be pushed into 2016.

Implications for SMSF investors?

In terms of market implications, the move by the Fed to leave rates on hold and indications that it won’t do anything to upset global growth are positive and should help allay some of the upwards pressure on the US dollar and downwards pressure on emerging market currencies in the short-term.

However, a Fed rate hike is likely still out there and uncertainty around it will likely return at some point. It’s likely to come at a time when there is less global uncertainty and so hopefully should mainly be a constraint on US shares as opposed to global shares.

Outlook for the Australian dollar

For Australia, the Fed’s decision is a mixed blessing. On the one hand, it would have been better to have seen the Fed able to raise interest rates as it would signal greater confidence in global growth and place ongoing downwards pressure on the value of the Australian dollar.

As it currently stands, there is a risk that an ‘on hold for now’ Fed will see the Australian dollar bounce a bit higher. Ultimately though, the downtrend in the Australian dollar is likely to resume – as the Fed is still likely to hike at some point, the RBA is likely to remain under pressure to cut and commodity prices remain weak.

There is no change to our view that the Australian dollar will fall to around $US0.60 in the next 12 months or so.

About the author
Head of Investment Strategy and Economics and Chief Economist at AMP Capital, Shane is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.
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