A rate hike in December is a given, but considerably more murkiness beyond that
• Fed appears to be more dovish: Federal Reserve Bank Chairman Powell noted that interest rates were “just below” estimates of neutral, dialling back from his view just a few months ago that rates were still “a long way from neutral”. At their last meeting, many officials in the Federal Open Market Committee expressed that it was time to drop the phrase “further gradual increases” from the monetary policy statement. In our view, these shifts suggest that the Fed’s commitment to raise rates beyond December may have waned.
More recently, while Fed Governor Lael Brainard maintained her position that rate hikes continued to be appropriate for now, she seemed to qualify that view with a slightly more dovish undertone. St. Louis Fed President James Bullard was notably more forthright, arguing that the Fed should consider a pause in December: this is the first time a Fed official of his seniority has said this.
• Explicit forward guidance was de-emphasized by the Fed: The minutes of the latest Fed meeting also underscore a shift in the central bank’s forward guidance policy: away from explicit guidance and toward reacting nimbly to incoming economic data.
Slightly lower growth and inflation aside, the US economy remains in fine fettle…
• Growth remains firm and above-trend: GDP expanded at a brisk 3.5% q/q (annualized) in 3Q18, down from 4.2% y/y in 2Q18. Growth was led by consumer spending which contributed 2.45 percentage points to growth. Net exports were the main drag, subtracting 1.9 percentage points from growth. Investment added just 0.25 percentage points to growth.
• Inflation unexpectedly eased: The core PCE deflator, the Fed’s preferred measure of inflation, rose 1.8% y/y in Oct 18, its slowest pace in 8 months, down from +2.0% in Sep 18.
• A virtuous cycle of labour market tightness, consumer ebullience, and private consumption portends well for the economy: While jobs growth fell to 155,000 in November from 237,000 in October, weather seems to have played a part in the slower pace of job creation. The unemployment rate continues to edge down, from 3.75% in October to 3.671% in November and wage growth was maintained at the 3.1% annualised pace in October. The Conference Board Consumer Confidence index came in at 135.7 in Nov 18, down just a tad from multi-year highs notched in Oct 18 (135.9). Real consumer spending grew 0.4% in October, helped by a 0.3% rise
in real disposable income. In addition, the personal savings rate slipped to 6.2% in October from 6.3% in Sep 18.
• However, trade is set to remain a drag: The goods trade deficit (seasonally adjusted) rose to a record high of USD77.2bn in Oct 18. Exports fell 0.6% after the surge in soybean exports to China finally reversed while imports edged up 0.1%. The important housing sector continues to slow…: The Case-Shiller Home Price Index was up 5.1% y/y in Sep 18, down from +5.5% in August. New home sales fell 12% y/y to 544,000 in Oct 18.
• …and the outlook for capital expenditure has weakened.
• The latest Senior Loan Officer Credit Survey showed that demand for commercial and industrial loans weakened substantially in 3Q18, even as banks continued to ease lending standards for such loans. The survey indicated a reduced borrowing appetite except for consumer loans which remained robust, corroborating our recent hunch that consumption spending will remain the sole driver of growth for the US economy as capex fades. The one exception could be technology-related spending, which is important for Asian exports of electronic components.
• The NFIB small business optimism index fell for the third consecutive month to a seven-month low of 104.8 in Nov 18, down from 107.4 in Oct 18. In the same vein, the proportion of firms making plans for capital spending slipped to a four-month low of 29% in Nov 18, down from 30% in Oct 18.
Assessment: A dovish turn by the Fed would be a mistake
On the whole, low inflation and easing growth appears to be moving the Fed into a dovish stance, setting the stage for a potential pause or slowdown in the hiking cycle in 2019.
There are two issues pertinent to developing Asian economies.
First, insofar as a more dovish Fed offers a reprieve in financial market pressures on the region, it may prove to be only temporary – interest rate differentials are likely to continue to widen off the back of shrinking global liquidity.
Second, the fact that the Fed Chairman could so quickly change his mind on how far away from neutral the current level of policy rates was, tells us that he and the Fed are operating with a great deal of uncertainty as to where the neutral rate is. Consequently, the path of monetary policy will be guided by the actual flow of data. We think that the manifest strength of the US consumer points to above-trend growth for the US economy for at least the next few quarters. Market reactions are likely to be much more volatile than before, with every twist and turn in each volatile data series causing market expectations to swing wildly.
In short, a dovish turn by the Fed carries incipient risks for emerging Asian markets: should the Fed pause tightening too soon, economic exuberance may spill over into overheating in the short term. Then the Fed would be forced to raise rates more abruptly, the last thing that emerging Asian markets