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Why the Fed could surprise the world next week with no rate hike

Federal Reserve Chairman Jerome Powell. REUTERS/Mary F. Calvert
Federal Reserve Chairman Jerome Powell. REUTERS/Mary F. Calvert

Trade war concerns coupled with fears of an economic slowdown have sent markets tumbling recently, and economists have taken notice.

Though it is still widely expected that the Federal Reserve will be raising interest rates at their Federal Open Market Committee (FOMC) meeting next week, Neil Dutta, head of economics at Renaissance Macro Research, argued that it’s not completely out of the question to skip a hike this month.

“The consensus overwhelmingly expects a rate hike next week,” Dutta said. “This conviction feels a bit too strong for our liking. We’d be buying the front end of the yield curve heading into this meeting.”

Dutta explained a few reasons for his argument for the Fed to skip a December hike including abating inflation pressures, slowing global growth, and increasing market volatility.

“At a minimum, we think a dovish hike is an okay baseline; the Fed hikes in December, but lowers the prospect of additional hikes in 2019,” Dutta added. “There is a decent chance – let’s say 30 to 40% – Hiking simply because they’ve “said they would for a long time” does not strike us as consistent with data dependence. Credibility is established as the Fed shows a willingness to change its views as conditions in the economy and markets evolve.”

Investors currently see a 73.2% chance of a rate hike following the December Fed meeting, according to the CME. Just one week ago, the probability for a rate hike on December 19 was at 84.4%.

Additionally on December 7, St Louis Fed President James Bullard said that the Fed should postpone a December rate hike because of an inverted yield curve. In a speech before the Indiana’s Bankers Association, Bullard stated that “the current level of the policy rate is about right.” Bullard is known for his dovish monetary policy stance and was the first Fed official to mention a December rate hike delay. Though he is not a voting member currently, he will be a voting member of the committee in 2019.

Bullard’s comments followed a disappointing November jobs report that was well below economists’ predictions. The U.S. economy added 155,000 jobs last month, which was less than the 198,000 expected.

Odds for 2019 rate hikes are also falling

Although consensus among economists remains in favor for a rate hike in December, some are beginning to lower estimates for 2019.

Goldman Sachs initially forecasted four rate hikes next year and still estimated that there is a 90% probability for a rate hike in this month, but now predicts a less than 50% chance of a rate increase in March.

“A decision to pause in March would also be consistent with the likelihood that tariff-related uncertainty will look particularly high around the end of the 90-day grace period on March 1,” Jan Hatzius, chief economist at Goldman Sachs, said on Sunday in a note to clients.

Hatzius still expects the central bank to continue to tighten monetary policy as he predicts the U.S. economy will to continue to grow in 2019, low unemployment and rising wages.

HSBC explained that the Fed’s language in the next meeting will be even more critical in predicting the central bank’s plan for next year. According to Kevin Logan, chief U.S. economist at HSBC, the word “gradual” will be a key indicator of the Fed’s intentions.

“The word ‘gradual’ had come to mean a rate hike at every other FOMC policy meeting. Dropping the word ‘gradual’ at this juncture would suggest that the policymakers are giving themselves leeway to move more slowly if they so choose,” Logan said.

Heidi Chung is a reporter at Yahoo Finance. Follow her on Twitter: @heidi_chung.

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