CICC, July 28 , According to Reuters, although analysts are chattering and believing that a slow inflation may prevent the Fed from raising interest rates soon, the financial market is very bright, and it is still possible that US policymakers will put in an extra rate hike in this year's timetable.
U.S. stocks are roaring near record highs; the dollar has depreciated at its highest rate in 15 years; despite the Fed hikes four times in the past 19 months, U.S. long-term Treasury yields are still falling.
"The Fed raises interest rates twice this year, and the financial environment remains loose," said Jim Caron, portfolio manager at Morgan Stanley Investment Management.
In fact, the financial environment is rarely looser than it is now.
According to the Bank of America Merrill Lynch fixed income index, since the Fed's first rate hike in December 2015, the yields of corporate bonds issued by the lowest-rated companies in the United States have fallen by nearly 22 percentage points to 10.6%.
These yields reflect the borrowing costs of companies with poor credit quality, which are usually much higher, with an average of 14.7% over the past 20 years.
Meanwhile, another indicator compiled by the Federal Reserve Bank of St. Louis, reflecting pressure on financial markets is close to a three-year low, hovering around its lowest ever.
These indicators show that the Federal Reserve's interest rate hike and suggest that it soon began to shrink its bond holdings of $4.2 trillion, which had almost no impact on the market's acquisition of low-interest funds.
In other words, when the Fed tried to tighten, the financial environment relaxed, indicating that policymakers have enough room to raise interest rates again, even in the face of a situation where inflation continues to fall below the Fed's 2% target.
"18 months after the start of interest rate hikes, the financial environment has been continuously relaxing, especially the tightening of credit spreads, which may pose a new problem for the Fed," said Shehriyar Antin, founder of Macro Insight Group in New York.
"This has certainly bothered the FAP (FOMC) and at least offset the impact of the recent decline in inflation," Antia said. Antia was a senior policy analyst at the New York Fed and knew more about the bank's president Dudley's ideas. Dudley has permanent voting rights in FOMC and has a great influence.
There are examples that can be followed by
In the past, there were many cases where monetary policy was postponed due to market fluctuations.
both occurred in 2013 and 2015 when the Federal Reserve delayed the normalization of monetary policy, as market volatility has tightened financial conditions to an unacceptable level.
On the other hand, loose financial situation gives Fed policymakers more room to take action.
Dow Jones Industrial Index, S&P 500 Index and Nasdaq (Nasdaq) index have set record highs in recent weeks.
The dollar index has fallen by more than 8.0% so far this year, with the worst performance since 2002 in the first seven months of this year, but this is beneficial to U.S. multinationals as their overseas profits are calculated in local currencies.
indicator 10-year U.S. bond yield has fallen slightly so far this year, and it has actually not changed from when the Fed first raised interest rates in December 2015.
The credit spread of corporate bonds is less than half of what they were 18 months ago, and the credit spread of bonds issued by weaker borrowers narrowed the largest. Credit spreads measure the premium of the yield on the Treasury bonds required by investors to purchase corporate bonds compared to the same period.
Therefore, American companies can borrow at low cost and are competitive overseas, while consumers are also enjoying wealth growth and able to finance their consumption.
“The Fed has huge room to continue to gradually normalize interest rates,” said Jim Paulsen, chief investment strategist at Leuthold Group.
Inflation is sluggish
Federal Chairman Yelen and other officials have indeed expressed caution about the recent weak inflation.
Some Fed officials may want to see further inflation rise before raising interest rates again, and the U.S. Federal Open Market Committee also seemed to express growing concerns about weak inflation in a policy statement on Wednesday.
The U.S. Consumer Price Index (CPI) rose 1.6% in the 12 months to June, the smallest increase since October 2016.It has been inferior to analyst expectations for four consecutive months.
However, other key Fed figures, including Dudley, are worried that not taking advantage of the current push up interest rates may cause financial conditions to become too relaxed and may lead to asset price bubbles. Fed officials also believe higher interest rates will provide them with more room to fight the next downturn.
The confrontation and tension between the two factions is also reflected in the market.
interest rate futures suggest that the probability of a third rate hike in 2017 is the same as a coin toss, but economists expect the Fed to start shrinking its $4.2 trillion bond portfolio later this year, a move that is expected to eventually tighten financial conditions without affecting economic growth.
"The Federal Reserve reduces its balance sheet by reducing its U.S. Treasury bonds and MBS holdings, which can directly affect financial conditions and can be said to not bring substantial changes to the economy," said Stephen Stanley, chief economist at Amherst Pierpont in Stanford, Connecticut.
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