So long September: Traders, analysts see Fed delaying rate hike after latest minutes

A screen shows the final tally for the Dow Jones Industrial Average on the floor of the New York Stock Exchange on Aug 19, 2015.
A screen shows the final tally for the Dow Jones Industrial Average on the floor of the New York Stock Exchange on Aug 19, 2015. PHOTO: REUTERS

NEY YORK (BLOOMBERG, AFP) - So much for September.

Traders gearing up for the Federal Reserve to raise interest-rates next month reversed course on Wednesday (Aug 19) after minutes from the central bank's July meeting showed policy makers were still waffling on whether the economy is strong enough to warrant higher borrowing costs.

That's far short of the confidence they expected to see from a central bank supposedly just weeks away from what would be the first increase in almost a decade.

The probability that futures traders assign to a rate boost next month slid to 36 per cent, the lowest since July, from about 50 per cent earlier in the day. The levels assume that the Fed's target will average 0.375 per cent after the first move. The chance of an increase at or before the Fed's December meeting dropped as well, to 65 per cent from 73 per cent Tuesday.

Fed officials were divided about whether the US economy is strong enough to withstand an interest rate increase at July's policy meeting, the minutes of the meeting showed Wednesday.

Although policy makers at the Federal Open Market Committee meeting viewed conditions getting closer to allowing the first rate hike in nearly nine years, they cited evidence that the time was not ripe.

As expected, the FOMC left unchanged the benchmark federal funds rate at the zero level, where it has been pegged since late 2008 to support the US economy's recovery from the Great Recession. But Fed Chair Janet Yellen has signaled that a hike is on track this year.

The record of the July 28-29 FOMC meeting gave no clear indication of when the Fed will pull the rate trigger.

"In our view, the minutes have lowered the probability of liftoff in September and raised the probability for December," Nomura Global Economics said in a client note.

"It's clear... that the Committee sees downside risk to its inflation outlook and it may need more evidence that inflation is moving in the right direction."

Moody's Analytics analyst Ryan Sweet said the minutes confirmed that a rate hike at the September 16-17 meeting remained possible, but was "not a slam dunk, and we believe the odds have diminished over the past couple of weeks."

FOMC participants highlighted tepid inflation, slack in the job market and low wage growth, and risks from China's economic slowdown as they considered raising near-zero borrowing costs.

"Most judged that the conditions for policy firming had not yet been achieved, but they noted that conditions were approaching that point," the minutes said.

Some FOMC participants emphasized the economy had made "significant progress" over the past few years and viewed conditions for a rate hike "as having been met or were confident that they would be met shortly."

A couple worried that an appreciable delay in hiking would result in an "undesirable increase in inflation" or otherwise hurt financial stability, while one member was ready to pull the trigger but would wait for additional data.

Officials generally agreed that job market conditions had improved. However, several noted that "some noticeable margins of slack remained," including a high share of employees working part time because full-time jobs were not available.

Some participants said they did not have enough information to make them "reasonably confident" that tepid inflation would move back to the Fed's 2.0 per cent target over the medium term, a key element of the Fed's dual mandate of price stability and maximum employment.

"Members are satisfied with improvements in the labor market, but it is inflation that has members leaning one way or the other," said Patrick Newport, US economist at IHS Global Insight.

"That's probably because the inflation numbers are a puzzle. The economy is nearing full employment, productivity has stalled, yet inflation shows no signs of taking off."

Earlier Wednesday, the Labor Department reported consumer prices rose a mere 0.2 per cent in July year-over-year, extending a slow rise since April.

China's slowdown also troubled Fed policy makers.

"While the recent Chinese stock market decline seemed to have had limited implications to date for the growth outlook in China, several participants noted that a material slowdown in Chinese economic activity could pose risks to the US economic outlook," the minutes said.

The FOMC meeting came before China's shock devaluation last week of the yuan, which many observers saw as a sign that its slowdown is deeper than thought.

The dovish FOMC minutes sent the dollar tumbling, ending the day down 0.8 per cent at US$1.1121 to the euro.

"I'm a bit surprised by the market reacting as much as that," said Vassili Serebriakov of BNP Paribas.

"I think the message was 'we're getting closer to hiking but we're not there yet.' Certainly, there's no clear signal of a rate hike in September and that's what's hurting the dollar."