US: Uncertainty to keep Fed's finger off the trigger in September

Although domestic economic data is moving in the right direction, the increased uncertainty on global growth and inflation over the past month is likely to keep the Fed off the trigger at the September FOMC meeting.
We now expect the first Fed funds rate hike to be delivered in December this year but stick to our view that the hiking cycle will be significantly faster than what is currently priced. We look for an average of 100bp in hikes per year.
We have updated our US yield forecast with the new fed funds rate path and now see a slower pace of increase in yields and less flattening of the curve in the coming 3-6 months. The projected rates remain above forward rates across the curve.
Our EUR/USD forecast is revised upwards: we now stress that the EUR/USD low is probably behind us. Some EUR/USD downside is still in store, but we now see the pair trade in the 1.08-1.12 interval on a 3-6M horizon moving higher further out. Specifically, we see EUR/USD at 1.13 in 1M, 1.10 in 3-6M, and 1.15 in 12M.

Downside risks to global growth have risen

Todayâ€™s weak PMI out of China add further to the rising sense of uncertainty about global growth and we expect the weakness in the Chinese PMI to extend into coming months (see Flash Comment China: Drop in Caixin PMI in August suggests substantial weaknessin Q3 and pressure on PBoC to ease further, 28 August). The sell-off in emerging markets has now fuelled a more general souring of risk sentiment across assets.

Adding to this, credit spreads in the US have widened lately, driven by the high-yield energy sector but with spillover to more general financing costs. Finally, the change to a more market-based currency regime in China has increased the impact of higher US rates to the effective USD. In particular, the weakness in the August Caixin PMI suggests that the pressure on China to ease policy further, including further depreciation of the CNY, has increased. The bottom line is that there is currently uncertainty about both the policy response from China and the magnitude of the weakness in emerging markets growth.

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