Fed’s Loretta Mester Hints at Rate Hike in November

Fed could hike interest rates despite the impending Presidential polls

Loretta Mester, President of the Federal Reserve Bank of Cleveland, has strongly hinted of a possible interest rate hike when the Federal Open Market Committee (FOMC) meets in Washington on November 1-2nd, 2016, a week before the U.S. Presidential polls, as reported by Bloomberg on October 4th, 2016. She stated that the Fed’s November meeting should be viewed as “live” for a policy decision, despite its proximity to the elections. Mester was one of three voters on the FOMC to dissent in favor of hiking interest rates when policy makers decided on September 21st, 2016 to leave interest rates unchanged.

The FOMC, which met on September 20-21st, 2016, in Washington amidst a slew of dismal economic developments, left short-term interest rates unchanged while it waited for more concrete evidence to emerge about the progress of the economy toward its pre-set 2% inflation target. The FOMC said that near-term risks to the economic outlook appeared roughly balanced. The committee also said that although the case for an increase in the federal funds rate had strengthened, it would wait for further evidence of continued progress toward its objectives.

While the unemployment rate was little changed in recent months, job gains have been solid, on average, while household spending has been growing strongly. The Fed said that it would continue to closely monitor inflation indicators and global economic and financial developments over the next few months. The target range for the benchmark federal funds rate change remains at 0.25% to 0.50%, static since the 0.25% increase in December 2015. Following the meeting, Fed Chairperson Janet Yellen said she did not see any evidence that low unemployment was triggering a rise in inflation that required a hike in interest rates.

Meanwhile, Mester said she expects growth to pick up in H2 FY16 and inflation to move towards the Fed’s 2% target over the next couple of years. While the argument for hiking rates was a preemptive one, she added that the economy was not yet overheating. Mester opined that the Fed should be looking ahead and not just waiting. The FOMC’s decisions to leave rates unchanged through six meetings this year comes amid risks from abroad and inconsistent signs of US economic growth.

Dollar climbs on Fed bets

Reacting to Mester’s hawkish comments, the dollar strengthened for the sixth straight day versus the yen, while sovereign bonds fell as American manufacturing data spurred bets that US interest rates would be hiked this year. A gauge of the greenback’s strength climbed to a two-week high and yields on benchmark US Treasuries increased for the third consecutive day.

The Bloomberg Dollar Spot Index, a gauge of the greenback against 10 major peers, rose 0.2% on October 4th, 2016. The yen slid 0.5% versus the dollar on October 4th, 2016, extending its longest run of losses since August 2016.

Source: Bloomberg
Source: Bloomberg

In September 2016, US manufacturers’ output and new orders expanded, pointing to growing confidence that the US economy is robust enough to withstand higher interest rates. The probability of US borrowing costs being raised by December 2016 stood at 61% on Monday, October 3rd, 2016, up 10 percentage points from a week earlier. Federal Bank of Richmond President Jeffrey Lacker, who was to speak on Tuesday, October 4th, 2016, is expected to throw more light on the outlook for US monetary policy in the near-term.

Rising U.S. stockpiles pull down crude, gold rises

Spurred by Mester’s comments and an increase in oil prices following the OPEC’s decision to curb crude output, a Treasury market gauge of inflation expectations advanced to a four-month high on October 3rd, 2016. The rate on similar-maturity U.S. Treasuries rose one basis point to 1.63%, after climbing six basis points over the last two sessions.

Meanwhile, crude oil WTI fell 0.72% to $49.47 a barrel, on October 5th, 2016, for the first time in a week after data showed that U.S. crude stockpiles expanded. Crude also fell after production from Libya, which is among the countries exempted from the OPEC output curbs, rose to 500,000 barrels a day and is expected to climb further this month, according to state oil officials.f2

Gold fell for a sixth day, its longest losing streak since August 2016. Growing expectations for a U.S. rate hike weigh on the metal as it does not bear interest. Gold is highly sensitive to rising U.S. interest rates, which increase the opportunity cost of holding bullion, while boosting the dollar, in which it is priced.f3

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