The Data Still Says “Go”

Ethan Harris, US economist at Bank of America Merrill Lynch, put this out to clients two days ago:

As the markets continue to sell-off, an increasingly popular view among investors is that the Fed won’t hike until next year. Global growth is weak, Chinese policy mistakes have destabilized their markets and the US equity market has finally succumbed to the pressure, with a roughly 10% correction. Thus far only a handful of economics teams at major houses have shifted their Fed call to next year, but both market pricing and most clients we talk to see a significant delay in Fed tightening.

We think some delay is possible, but a big delay is unlikely. It is always dangerous to make big forecast changes during periods of turmoil in markets. It is a bit like going food shopping right before dinner—your gut, instead of your mind, starts driving your decisions. Yes, if the Fed met today, they would very likely take a wait and see attitude and delay hiking. Why create further market volatility? Why not wait to see whether this is an economically important shock? However, there are three weeks before the Fed decides. If the markets stabilize, the Fed outlook will feel a lot different.

In the 48 hours since this note, the US economic data has continued to come in stronger than expected. Yesterday’s 3.7% revised print for 2Q GDP growth was the obvious highlight, along with some new data this morning on consumption and personal income.


Personal spending, measuring how much Americans paid for everything from home rent to dental care, rose 0.3% in July from a month earlier, the Commerce Department said Friday. Consumption climbed 0.3% in June and 0.8% in May.

Personal income, reflecting Americans’ pretax earnings from salaries and investments, climbed 0.4%, replicating the gains of the prior three months. Within that category, workers’ wages and salaries climbed at the fastest pace since last November, as did their disposable income.

Combine this with a sanguine James Bullard interview on Bloomberg TV this morning, and the chips are lining up behind a “go” for liftoff at the FOMC’s September conclave. The Fed views the market volatility emanating from emerging markets as something worth watching, but not necessarily anything that should derail its own plans at the moment. The transmission mechanism from the Shanghai Composite shitshow to the US economy’s fundamentals simply isn’t apparent at the moment.

My preference is a Fed hike of 25 basis points in September and then nothing in October. I think we’ve already paid for it in blood and tears and the market is fed up (pun intended) with the whole will-they-or-won’t-they drama of the last 9 months.

Paradoxically, the thing that markets seem to fear most – the first rate hike – may end up being the catalyst that shoots stocks through the top of the range. It’s pure psychology, not economics, but removing a key piece of uncertainty has frequently served as an upside catalyst in recent years. The first hike and the market’s reaction may be just another example of this.


When the data say “go” but the markets say “no”
Bank of America Merrill Lynch – August 26th 2015

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