China, market turmoil may steer Fed off its course

The U.S. Federal Open Market Committee is in the midst of a two-day policy meeting after flagging off a historic interest rate hike cycle in December but a slowdown in China and convulsions in global markets could steer it off its course later this year.

After all, the Chinese equity and currency markets have had a rocky start to the year and the world's second-largest economy is growing at its slowest pace in 25 years. Meanwhile, crude oil prices have plunged to fresh 12-year lows below $30 a barrel, prompting fears of a global recession.

That presents an inclement backdrop for the Fed, whose projections imply four interest rate increases this year.

"The main thing to look out for this week is how much emphasis (the Fed is) going to put on international developments; I think they will highlight these issues again like how they've done occasionally in the past and I think that will bring market expectations down to somewhere like one more (rate hikes) this year, maybe two," said Jesper Bargmann, Nordea Market's Asia trading head.

"They will mention something (about) the global economy affecting the U.S. economy."


A small group of influential investors have spoken about the likelihood of the Fed reversing course including Ray Dalio, founder of the world's largest hedge fund.


Jeff Gundlach, widely considered to be one of the world's most influential bond investors, Tuesday said the Fed risks humiliation if it doesn't dial back on its plans to aggressively tighten monetary policy.

As no press conference is scheduled after the meeting, FOMC's statement will be scrutinized for both implicit and explicit messages.


The last time the Fed mentioned concerns and elaborated on external conditions was in September last year. Financial markets in the run up to that meeting had been rocked by China's move to devalue the yuan, a move that fanned fears over the health of the Chinese economy.

Then the Fed said specifically then that it was "monitoring developments abroad" and that "global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term."

The move prompted criticisms from some quarters who said it was inappropriate for the U.S. central bank to react to broad financial market turmoil as the focus should be the country's growth and labor markets.

Even so, the Fed is likely to remain sensitive to the global macro-environment, although that is unlikely to derail its path, said DBS' senior FX economist, Philip Wee. The house is expecting four Fed rate hikes this year.


"We do think it will more sensitive to what's happening around the world with regards to low oil prices, the other central banks toning down inflation expectations and of course, the volatility involving China," said Wee.

Nomura analysts said in a report last Friday (January 22) that they expect the Fed to acknowledge the volatility in the financial markets this year but do not expect it to change key policy language.

"There's no way they're going to try to have any reversal of policy. From their point of view, markets are volatile when you start any rate hike cycle…that's no reason to stop…The bulk of (the U.S.) economy is doing really well," said Bank of Singapore's chief economist, Richard Jerram.

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