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Should the Fed raise interest rates in December?
Reasons for the Federal Reserve to raise interest rates in December
FED officials have made a conscious effort to not surprise the market following averse reactions such as the 2013. Some argue that policymakers would only proceed with major policy changes (such as raise interest rates) when they are more than 50% priced-in, and recent FED communications did just that – setting investor expectations of a December “liftoff.”
Below is a time-series of market-implied probability of December “liftoff.” The more dovish than expected September FOMC successfully “reset” investor expectations following China growth concerns and another bout of energy weakness. Nevertheless, hawkish communications at the October FOMC and subsequent policy speeches again raised “liftoff” expectations.
Financial markets would react with shock if the FED goes against the “December consensus” without notable changes in economic conditions, downside surprises may include a significantly weaker-than-expected Dec 4th employment report, oil dropping into the low 30s range, another round of below-consensus China data (major data release on Nov 30th).
In terms of data, I would like to highlight the steady rise in core inflation (ex-food energy), and how energy weakness is weighing on headline inflation. Inflation had been the FED’s main concern, and if the FED is willing to look past energy price decline as “transient,” and assuming oil prices stay in the current range and China growth doesn’t deteriorate, FED policymakers will ease their concerns on inflation at the December meeting, paving the way for rate hike.
In terms of the labor market, U-6 and U-3 are both crossing into “pre-recession” levels, and involuntary part-time workers have declined further.
Please also refer to:
Next article11 24 2015 | by Victor Xing | Capital Markets