The Chinese economy and the Federal Reserve meeting next week continue to dominate the financial headlines. The uncertainty as to what the Federal Reserve might do, and its subsequent impact on asset prices remains the topic of much debate. The Financial Times led on Wednesday with the headlines "Fed urged to hold fire on rates or risk sparking emerging market panic", after comments from the World Bank. Citi are wary of the Fed making a policy error if they raise rates next week. Lawrence Summers the renowned economist appeared on CNBC expressing the view that he believes now is not the prudent time to take risks with interest rates. The IMF likewise had advised against the raising of rates at next week's meeting.
The investing community seems to be remarkably worked up about what is likely to be a very modest move, if any, by the Federal Reserve. We continue to live in strange times, an ongoing legacy of the events of eight years ago. The possibility of higher rates should be a positive, it's a sign that the Fed believe that the economy is in recovery, that the US economy is not in a Japanese style deflationary zero growth world. The action of the Fed not to move could lead the market to take the view that the economy may be in worse shape than the economists forecast.
We used to live in a world where bad news was good news as it meant rates stayed lower for longer, do we now live in a world where any news is bad news? If the economy is stronger that's bad news for risk assets as it encourages investors to believe the Fed will raise rates. Leaving rates unchanged is bad news as it’s a sign of a weaker economy and the Fed has run out of ammunition to stimulate economic growth. It seems odd to believe you can have it both ways.
The reality is as we have said before risk assets don't like uncertainty, what they like are the facts, sell first ask questions later. The fear that raising rates will further impact emerging markets, when sentiment is already on its knees on that region. This fear is based on the view that higher rates means stronger dollar and leads to a flight of capital from those regions.
The main impact of this uncertainty continues to be felt mainly in the equity markets, as bond prices remain stable. The Vix index remains above recent trading levels but well below where it was a couple of weeks ago.
Closer to home UK interest rates were left unchanged for another month, in line with expectations. The vote remained at 8-1 for rates to remain where they are. The reality for the US and UK economies could well be summed up in the wording of the minutes from the latest monetary policy meeting. Any rise in rates will be modest and remain below historic levels for years to come. The majority on the committee agreed that "downside risks to world activity had probably increased", but this did not yet translate into a materially weaker outlook for the UK economy. The Fed should be brave and act; at least it would remove the uncertainty, even if it does go against the advice of the IMF and the World Bank.