Thursday, November 17, 2016

Here’s One Reason Why The Fed Might Not Hike Interest Rates In December

Rising dollar, Treasury yields have already ratcheted up borrowing costs.


By Joseph Adinolfi
MarketWatch
November 17, 2016



Post-election, financial conditions in the U.S. are tightening — fast. That poses a problem for the Federal Reserve, which has intimated that it will raise interest rates in December, as well as the investors who’ve positioned their portfolios accordingly.

Earlier this week, the Goldman Sachs Financial Conditions index touched its highest level since March, driven primarily by a sharp rise in Treasury yields and the U.S. dollar.

The U.S. dollar index DXY, +0.02% , a key gauge of the dollar’s value, reached a 13-year high on Wednesday, while the yield on the 10-year Treasury TMUBMUSD10Y, -0.99% remains near its highest level in a year.

To top it off, U.S. stocks have risen rapidly over the past week, with the Dow Jones Industrial Average DJIA, -0.29% logging four consecutive record closes.

Tighter financial conditions typically signal that borrowing costs are rising, making it more expensive for companies to expand. By raising interest rates now, the Fed risks ratcheting up borrowing costs too quickly, which could weigh on economic growth at a point when the U.S. is finding greater traction.

The Fed and a host of financial institutions maintain their own financial conditions indexes that incorporate many components. Goldman’s index, for instance, factors in the Fed’s trade-weighted dollar index, the Fed funds rate target (the Fed’s primary interest-rate tool), the 10-year Treasury yield, the spread on BBB-rated credits and the level of the S&P 500.

Because of the dollar’s role as a global reserve currency, tighter borrowing conditions in the U.S. can easily bleed into other economies. The Fed will likely take that into account when deciding whether to hike, said Doug Borthwick, managing director at Chapdelaine FX, a subsidiary of Tullett Prebon.

“It could make it harder for emerging-market economies to pay back their dollar-denominated debt,” Borthwick said.

In a year where the consensus view has repeatedly proven incorrect, investors might approach the market-based odds of a rate hike — which are currently about 90%, according to CME Group’s FedWatch tool — with assiduous skepticism.


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