Markets have been speculating for months about whether the U.S. Federal Reserve would raise interest rates in September. The day has finally arrived, and interestingly, there’s much less certainty now about which way it will go than there was just a few weeks earlier.
In August, more than three-quarters of economists surveyed by Bloomberg expected a rate hike this month. Now, only about half do. Traders were also more certain back then, putting the odds at about 50-50. Now the likelihood of a rate hike based on Fed Funds Futures is about one in four.
The Federal Reserve may be on the verge of lifting rates for the first time in more than nine years because unemployment has dropped to pre-crisis levels, the housing market is the healthiest it’s been in 15 years and the economic recovery, while tepid, has continued.
Investors’ and economists’ uncertainty, meanwhile, has been fueled by weak growth in China, Europe, and Latin America, giving the Fed pause about whether now’s the right time to start the return to normal.
There is growing alarm that a rate hike will make things even worse for the rest of the world. The Fed risks creating “panic and turmoil” across emerging markets such as China and India and triggering a “global debt crisis.”
The reality, however, will likely be very different. For one, the Fed lacks the power it once did, meaning the actual impact of a rate hike will be more muted than people think. Second, the effect of uncertainty and speculation may be far worse than an actual change in rates, which is why central bankers in emerging markets are pushing their American counterparts to hurry up and raise them already.
The Fed’s Waning Influence
The Fed, and more accurately the rate-setting Federal Open Market Committee (FOMC), is simply no longer the center of the universe it once was, because the central banks of China, India and the eurozone have all become monetary policy hubs in their own right.
The U.S. central bank may still be preeminent, but the People’s Bank of China, the Reserve Bank of India, and the European Central Bank are all growing more influential all the time. That’s particularly true of China’s central bank, which boasts the world’s largest stash of foreign currency reserves (about US$3.8 trillion) and increasingly hopes to make its influence felt beyond its borders.
Some argue that central banks in general, not just the Fed, are losing their ability to affect financial markets as they intend, especially since the financial crisis depleted their arsenal of tools. Those emergency measures resulted in more than a half-decade of near-zero interest rates and a world awash in U.S. dollars. And that poses another problem.
