FED: Preparing for a December rate hike

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The Federal Reserve (Fed) will hold a two-day meeting this week ending on Wednesday with its decision on interest rates.

We expect no change in interest rates. In the press conference following the meeting Fed Chair Janet Yellen is expected to prepare the markets for an interest-rate hike later this year.

The probability that the Federal Open Market Committee (FOMC) will hike the Fed funds target rate already at this week’s meeting is pretty low, given the recent flow of disappointing US economic data.

The FOMC meeting on 14 December might be best suited to act on the interest-rate front as the meeting on 2 November is just ahead of the presidential elections, which are creating considerable uncertainty and risk aversion, convincing the Fed to stay put.

The Fed seems to have a strong determination to proceed with rate hikes as soon as economic data allows it to do so. Sufficient domestic price pressure is one reason why the Fed is ready to act on the interest-rate front. Service price inflation is up by 3% year on year, according to the latest inflation data published on Friday.

At the same time, international deflationary forces are becoming weaker as the growth outlook for Europe and China seems to have stabilised. Financial markets are currently pricing in a 20% probability of a rate hike this week and a 55% probability of a rate hike in December.

Increasing probabilities for the December rate hike will support the US dollar in the coming months. We expect this dollar strength to become the major reason why the Fed will eventually refrain from actually hiking rates in December and there-fore we stick to our view that the Fed will act only in Q1 2017.

David Kohl is chief currency strategist and head Economist Germany at Julius Baer