Call it the tail wagging the dog. After holding interest rates at rock-bottom levels since 2008 to support the U.S. economy, the Federal Reserve’s decision whether to raise them this month may boil down to what happens in financial markets during the next five trading days.
Volatility in currencies, bonds and stocks has soared to multi-month highs in recent weeks, threatening the central bank’s well-telegraphed script for tightening monetary policy for the first time since 2006. While policy makers have already seen most of the key economic data that’ll be available by the time they meet next week, the surge in market volatility means a decision to raise rates may go down to the wire.
“It’s a very close call -- it’ll depend on what financial markets are doing between now and next week,” said Adnan Akant, head of currencies at Fischer Francis Trees & Watts Inc. in New York, which had $38.7 billion under management as of July. The Fed’s decision “shouldn’t depend on what the next week is going to look like, but I think it will, in reality.”
Asset-price swings have accelerated after last month’s surprise currency devaluation by the the People’s Bank of China and ensuing rout in the country’s stock market, leaving the Fed watching markets as much as markets are watching the Fed. Traders have pushed out bets on an initial Fed rate increase to December, pared wagers on the dollar and sold U.S. stocks amid concern that a slowdown in China will weigh on global growth and derail the U.S. recovery.
They’re pricing in a 28 percent chance that the Fed raises rates at next week’s meeting, based on the assumption that the effective fed funds rate will average 0.375 percent after liftoff. Traders see a 59 percent probability of a rate increase by December.
A gauge of price swings in currencies last week extended its longest streak of gains since January, JPMorgan Chase & Co. data show. Treasury volatility also climbed, with the Bank of America Merrill Lynch MOVE Index touching a six-month high on Aug. 24. The Chicago Board Options Exchange Volatility Index -- which tracks equity price swings and is known as the VIX-- rose to its highest in six-and-a-half years the same day.
Policy makers, including Fed Bank of Atlanta President Dennis Lockhart, New York Fed President William C. Dudley and Vice Chairman Stanley Fischer have said they’re watching recent market turmoil before the central bank’s Sept. 16-17 meeting. Lockhart said Aug. 24 that the Fed’s path was being complicated by China, while Dudley said two days later that turbulence made the case for a September move “less compelling.”
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