Fed Credibility Test Looms as Market Doubts September Rate Rise

How Much Does Janet Yellen Care About the Selloff?

Futures traders are starting to bet the Federal Reserve will put off raising interest rates. Janet Yellen shouldn’t heed them, said Kay Van-Petersen, a strategist at Saxo Capital Markets.

Contracts on the fed funds rate show traders cut the odds of a September increase by the Fed to 28 percent on Monday, from 54 percent on Aug. 7. Investors’ doubts that the Fed will tighten policy for the first time since 2006 have been fueled by a rout that erased more than $5 trillion from the value of global equities since China unexpectedly devalued the yuan on Aug. 11, and sent commodity prices to a 16-year low.

The U.S. is showing it is ready for higher interest rates and Yellen needs to deliver them, Van-Petersen said. While Fed officials flagged inflation concerns at their late July meeting, they indicated the economy was “approaching that point” where it could sustain tighter policy. The Fed has held rates at rock-bottom levels since 2008.

“The Fed should raise rates, even if the markets sell off; it should be the economy first,” Singapore-based Van-Petersen said Monday. “The very worst thing they could do is let the market dictate what they should do.”

The world has been adjusting to the prospect of interest-rate increases for the U.S. and the U.K. even as most central banks attempt to stimulate growth by adding accommodation. China’s surprise devaluation this month may spur its exports by loosening the currency’s connection to the dollar.

Fed futures show traders are still clinging to expectations for a December rate increase, where they now see a 52 percent chance for a move to 0.5 percent, down from 77 percent odds Aug. 7. The figures are based on the assumption that the effective fed funds rate will average 0.375 percent after the first increase.

Costs Dropping

Treasury 10-year yields fell below 2 percent for the first time since April and inflation expectations have dropped to the lowest since January as the greenback’s gains versus major peers drive down the cost of imports and with crude oil sliding to six-year lows. That’s helped create a policy conundrum for the Fed as strong jobs growth and the lowest unemployment since 2008 have led to the weakest wage growth for any U.S. economic recovery since at least the 1960s.

Having spelled out loud and clear the expectation for higher rates, Fed Chair Yellen needs to deliver to restore the waning credibility of the world’s central bankers, Saxo’s Van-Petersen said. She also needs to build up ammunition to counter the next economic downturn, he said.

“If they don’t raise this year, after delaying it from March to April and to now September, then no one will believe whatever they say in the future,” according to Van-Petersen. “We seem to have forgotten that ups and downs are part of the business cycle.”

For more, read this QuickTake: The Fed’s Countdown

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