Emerging Markets debt putting pressure on the Fed to not normalise rates too fast

When do you expect the Fed next interest rate hike?

The short answer to this question is when the US inflation rate hits it 2% per annum target rate.  With the current Inflation rate of 0.8% per annum last month, we must keep an eye on raw commodities prices, in particular Crude Oil, as this has a feeder effect into prices across the spectrum.  As we are heading into a general presidential election in the USA, I expect the US FED to sit on the sidelines until then at the very least.

Which will be the interest rate level where the Fed will stop hiking at?

We can only go be the US FED’s dot plot, which shows that the central bank rate could range from 2% to 3.5% by the end of 2018, and with a longer term projection of the 2.75% to 3.75%.  I think this is optimistic, and would largely depend on the state of the US and Global economies.  As we know, a lot can happen +3 years from now.

Do you expect an acceleration in the rate hike pace in the upcoming months?

Quite simply, no.  I expect the US FED to be quite cautious with their rate hikes within the next 3-year time horizon.

What’s the Fed looking more closely when deciding their monetary policy: employment figures or inflation levels?

Both.  The reason being is the US FED have two major measures that determine rate decisions, yet, as we know that the USA is running at full employment and have met these criteria, perhaps more emphasis will be on inflation levels.

Can the Fed sustain a tightening cycle when all the other major central banks are on an easing one?

This is a very complicated and interesting topic.  On one hand, this type of divergence in monetary policies will only strengthen the USD, which is to the advantage of the consumer economy that the USA is and should expand its GDP.  On the other hand, it reduces the exporting activity of the USA, as they become more uncompetitive and raises imports, which may lead to some contractions in some sectors within the USA and its GDP.  As for the global economy, this can create some issues with the Emerging Markets that have binged on USD denominated debt due to the cheap credit and weak USD in the past (refer to previous article link here).  Pressure may mount on US FED to not normalise central bank rates too fast in particular to this latter risk, of which, the IMF has warned about in the past.

Do you think inflation can be a problem in the long-term if the Fed doesn’t “normalize” its policy soon?

There is a possibility that the cheap credit may create a vicious cycle of credit binging and inflate asset prices.  At present this doesn’t seem to be the case, given the USA have been running at low interest rates for several years now.  Most western economies are facing weaker demographics as the next generations are smaller in population size than the baby-boomers era, who are now retiring and consuming less.  The weaker demographics is more pronounced in European countries and Japan, and but less so in the USA, but nonetheless, in the USA it points to moderate consumption based on the peak spending for the average human usually around the age of 40 years (eg when they need to up-size their dwelling, send children to school, etc etc).

Is a return of QE policy something to consider in the mid-to-long term?

Moderate inflation is important to try and ensure that tax revenues grow to counter the growing tax payer debts.  I believe that Monetary policy and QE had failed to stimulate US inflation above the 2% annual target.  With the USA at full employment, and US Taxpayer Debt at roughly 105% of USA GDP, employing alternative measures such as Fiscal policies to stimulate the economy may not be the most appropriate as it may stimulate economic growth, but not necessarily inflation.  So that leaves us with the age old question of what can they do next?  Is QE going to solve the problem of inflation, by cashing-up Financial Institutions to extend further credit, or punishing the baby-boomer savings with negative rates as they enter retirement.  I’m afraid I don’t have the answer to this question, and perhaps neither does the US FED.

*This is one of the 31 answers to the FXSurvey. You can read the full results of the survey here.