Crucially, inflation remains very slow, both headline and core. Lower commodity prices and US dollar strength should keep inflation in check for longer. It is hard to see how the Fed can be ‘reasonably confident’ that inflationary pressures are set to resurface soon. Given the uncertainty, for an inflation targeting central bank, this is not a rate hiking environment.
Additionally, external risks are still out there, particularly as emerging markets continue facing headwinds from a slowing China, lower commodity prices and less accommodating financial conditions globally.
The latter in particular is one of the most important reasons why I believe the Fed is unlikely to move this week. Over the past year US financial conditions have tightened significantly on the back of the strong US dollar—and this tightening was accelerated during the August sell-off as equities fell and credit spreads widened.
This tightening alone is equivalent to a few rate hikes which, if sustained, could ultimately result in slower US growth next year. Some Fed officials referred in the past to financial conditions as an important metric they watch—provided, this is still the case, the magnitude of the recent moves should certainly seize their attention. Given the overall uncertainty about the state of the global economy (at least as perceived by the markets) and the costs of hiking too early, the case for remaining in the ‘wait and see mode’ is well intact for now.”
