Markets belt up for likely Fed action

World Bank warns of 'perfect storm of dangers' for developing countries

WASHINGTON • Financial markets that have been buffeted by the prospect of the first United States interest rate hike in almost a decade are buckling up as the Federal Reserve is all set to announce its decision early tomorrow (Singapore time).

An uncommon debate has raged over whether the US central bank should go ahead with a quarter-point increase to the Federal funds rate that would nevertheless mark a crucial break with the Fed's crisis stance since 2008.

By most assessments the American economy, with unemployment at 5.1 per cent and moderate growth, is strong enough now that holding the rate at zero per cent is no longer warranted.

Demolition work in Maryland. With the US unemployment at 5.1 per cent and moderate growth, the US economy is, by most assessments, strong enough now that holding the Fed rate at zero per cent is no longer warranted. PHOTO: REUTERS

The initial hike would likely begin a series of increases towards more "normal" levels of around 3 per cent over the next couple of years.

But to many economists, the slowdown of global economic activity, particularly in China, now poses a risk to the United States' growth and an interest rate hike could set the economy back.

And many others say it could cause new problems in nervous global markets at just the wrong time.

The World Bank warned in a report on Tuesday of a "perfect storm" of dangers, including a freeze in capital flows, for developing countries as the Fed tightens monetary policy.

"Given the substantial risks involved, they would do well to buckle their seatbelts in case the ride gets bumpy," said Mr Carlos Arteta, lead economist in the bank's Development Prospects Group.

The policy-setting Federal Open Market Committee (FOMC), led by Fed chair Janet Yellen, began its two-day meeting yesterday, and its decision will be announced at 1800 GMT today (Singapore time 2am tomorrow).

Then Dr Yellen will undertake the delicate challenge of explaining the decision at a press conference, with whatever she says as crucial to markets as the decision itself.

The Fed has been signalling the coming rate rise since 2013 and Dr Yellen has repeatedly said in recent months that it would probably come by year-end.

But the depth of China's problems - underscored by the Aug 11 devaluation of the yuan and the plunge in Chinese stocks - introduced new risks not only to other emerging economies but also, potentially, to the US.

Last week, Dartmouth economics professor Andrew Levin, who had worked at the Fed for 20 years, argued that the American economy still harbours weaknesses that undermine the argument to increase interest rates.

Tightening policy at this point "would be a serious policy error", he said.

On the other hand, tired by all the talk while their interest rates have already jumped and their currencies have fallen, some of the world's biggest emerging economies are pleading to end their agony and take the big step.

"It's preferable to have a move early on and advertised, a slow move up rather than the Fed be forced to tighten more significantly down the line," Indian central bank governor Raghuram Rajan said last month.

Even if the FOMC demurs this week, Dr Yellen's forecast could still hold: the panel has two more meetings left in 2015, one at the end of next month and one in mid-December.

Mr Charles Collyns, chief economist at the Institute of International Finance, said that market volatility will persist in any case, because the US and British economies and central banks are moving in the opposite direction to much of the rest of the world.

"This divergence, together with growing divergence in economic growth between mature and emerging markets, will generate market uncertainty and volatility in the period ahead, whatever the Fed decides on Thursday," Mr Collyns said.


A version of this article appeared in the print edition of The Straits Times on September 17, 2015, with the headline 'Markets belt up for likely Fed action'. Print Edition | Subscribe