After a summer of economic malaise, there's little doubt that the Federal Reserve has moved its much-anticipated next interest-rate hike to the back burner. This week, observers are hoping the U.S. central bank will signal just how much it has turned down the heat.
A few months ago, next Wednesday's meeting of the Fed's policy-setting Federal Open Market Committee had been circled by most Fed watchers as the date the bank would raise its key federal-funds rate again, delivering the long-awaited follow-up to last December's rate increase. After some temporary setbacks in the U.S. economy early in the year, growth would be back on the fast track by then, the prevailing thinking went. But now, those same people not only widely expect the Fed to hold its key rate steady in its current 0.25-to-0.5-per-cent range on Wednesday, but many have begun to wonder whether there will be a rate hike in 2016 at all. They'll be looking to fresh information coming out of the Fed that day – not only the traditionally terse rate-decision statement, but the quarterly update of economic forecasts and the press conference with Fed chair Janet Yellen that will accompany it – to better understand just how far away the Fed's rate-hike horizon has shifted.
The issue has been the surprisingly sluggish and uneven U.S. economy for much of the year. After the second quarter posted real GDP growth of just 1.1 per cent annualized, a solid start to the third quarter had raised hopes that the economy had righted itself; but the data for August suggest another stalling.
Job growth, probably the most important indicator for the Fed, totalled just 151,000 last month, a far cry from July's 275,000. The Institute for Supply Management's closely watched index of manufacturing activity fell below its midpoint of 50, implying a contraction in the sector. The ISM's services-sector index hit a six-and-a-half-year low.
Meanwhile, despite a bigger-than-expected rise in the consumer price index in August, inflation is tracking at barely over 1 per cent annually, a far cry from the Fed's 2-per-cent objective – suggesting no pressing need to cool inflation with higher rates.
If there was even a remote chance that the Fed might overlook August's dark economic clouds and still raise rates this week, last Thursday's weak data put the final nails in the coffin. Retail sales fell 0.3 per cent month over month in August. And industrial production sank a bigger-than-expected 0.4 per cent in the same month.
"This probably seals the deal," wrote National Bank Financial senior economist Krishen Rangasamy in a research note. "The Fed may want to err on the side of caution and delay rate hikes for a few months."
Indeed, the bond market is now pricing in only a 20-per-cent chance of a rate hike at this meeting, down from 62 per cent four months ago. The majority of traders are still betting on an increase at the December meeting, but it's a close call – just 54 per cent.
"A data-dependent central bank will have to depend on seeing something better to hike in December," said Canadian Imperial Bank of Commerce chief economist Avery Shenfeld in a research report.
December looks like an attractive target for a couple of reasons. First, it is the next time, after this week, that the rate decision will be accompanied by a quarterly economic-outlook update and a press conference. Though Ms. Yellen has said that every Fed meeting is "live" – i.e. that rate moves are entirely possible at any meeting – most observers believe the Fed much prefers to make rate changes at meetings where it has the outlook and press conference to more fully explain its thinking.
Perhaps an even more compelling reason, though, is the looming U.S. presidential election. With controversial Republican nominee Donald Trump now polling in a virtual dead heat with Democratic hopeful Hillary Clinton, the election has become a growing source of economic and financial-market uncertainty. The Fed will be hesitant to throw the curve ball of a rate hike into the pre-election mix, and would likely want to assess the fallout from the vote before considering a rate increase.
While the market waits, it will have plenty to chew on with the economic-outlook update and Ms. Yellen's press conference. What will almost certainly garner the heavy attention will be the Fed's closely scrutinized "dot plot," contained in the outlook documents.
This chart, which identifies where individual participants on the FOMC believe the level of the key interest rate will be at the end of each of the next three years, is considered an essential indicator of the likely pace of Fed rates.
In the Fed's last quarterly outlook, in June, the median forecast of participants was that the rate would be half a percentage point higher than its current level by the end of 2016 – implying two quarter-percentage-point hikes in the second half of the year – and would be in the range of 1.5 to 1.75 per cent by the end of 2017.
Now that it looks near certain that the end-of-2016 expectation has been scaled back, the markets will focus on how that has impacted the FOMC's view on the pace of rate hikes next year and beyond. If the dot plot has changed significantly, Ms. Yellen can expect a grilling from the press corps.