What Factors Will Influence the Fed’s Rate Hike Decision the Most?

FOMC meeting

Market participants are closely watching the two-day Federal Open Market Committee (or FOMC) meeting from March 15–16, 2016, for clues about when the US central bank may raise interest rates again. After the interest rate cuts announcements in the Eurozone, Japan, and New Zealand, investors are confident that the US economy is strengthening, albeit slowly, and ready for another rate hike. Now, we will look at key factors that will influence the timing of the next rate hike.

What Factors Will Influence the Fed’s Rate Hike Decision the Most?
Volatility in oil prices

Oil prices rebounded last month on the hopes that oil-producing nations would agree to cut oil production. With the rise in oil prices, the stock market also rallied. However, Iran rejected the proposal to join other nations in freezing oil production. As a result, oil prices plunged, raising fresh concerns about oversupply amid a slowdown in demand from large industrial countries such as China coupled with the shale energy boom in the US. Shares of energy companies such as Exxon Mobil (XOM), Chevron (CVX), ConocoPhillips (COP), and Royal Dutch Shell (RDS.A) were down.

Economic indicators

Non-farm payrolls rose by 242,000 jobs in February, and the unemployment rate was steady at 4.9%. Initial jobless claims also fell by 18,000 to a seasonally adjusted 259,000 for the week ended March 5, 2016, which indicated that the labor market is strengthening.

The personal consumption expenditure (or PCE) index, the Federal Reserve’s preferred measure of inflation, has also risen. The Fed’s target inflation rate is 2%. Further, the rise in consumer spending and an uptick in the manufacturing index have reduced the fear of recession. Thus, improvement in the labor market and firming inflation is paving the way for a rate hike.

Global economic turmoil

The global economic turmoil led to a sell-off in stocks, a rise in corporate borrowing costs, and a strengthening dollar that reduced US exports. Fed policymakers signaled that an anticipated March rate increase was likely off the table, in part because the global financial markets were weak and they offset the collective growth in the labor market, US economy, and inflation.

Outlook

The Fed may not hike interest rates in this meeting, but it may announce another rise in interest rates in mid-2016. The Fed will assess the global financial scenario and look at how commodity prices are moving. It will also look at how the Chinese economy is faring.

Further, market participants expect that we may see two or three rates in 2016, depending how global events pan out. In such a scenario, investors can choose to invest in short or intermediate maturity bond mutual funds like the Oppenheimer Limited-Term Government Fund Class A (OPGVX), the American Funds The Bond Fund of America – Class A (ABNDX) or ETFs like the iShares 1-3 Years Treasury Bond Fund (SHY) and the iShares 7-10 Year Treasury Bond Fund (IEF).

In the next article, we will look at how investment-grade bond yields and spreads have fared year-to-date.