Moody's: Fed rate hike could be delayed

ANKARA

The U.S. Federal Reserve is likely to delay its next rate hike ratings agency Moody's has said, citing specific economic indicators that the Fed particularly takes into account.

Moody’s Capital Markets Research Chief Economist John Lonski said in a note on Friday that the 25.8 percent decline in the base metals price index, accompanied by high-yield bond spreads over 700 basis points (bps) pointed to a long delay in further rate hikes by the U.S. Federal Reserve’s Open Markets Committee (FOMC).

The FOMC raised interest rates on Dec. 16 to the range of 0.25-0.50 percent from zero to 0.25 percent.

“The futures market does not expect another rate hike until the June 15 meeting of the FOMC,” Lonski explained.

“Do not be surprised if the next rate hike does not occur until the high-yield bond spread breaks well under 700 bps.,” Lonski said.

The first indicator that Lonksi sees as pertinent is the base metals price index:

“As of Jan. 13, the base metals price index — one of the better coincident indicators of global economic activity — was off by 7.3 percent since year-end 2015 and down by 26.4 percent from a year earlier.”

The drop in this index is a sure sign of weak global growth, Lonski explained.

“More than a cursory examination of the data favors slower-than-anticipated growth for the world economy. The annual increase in 2015 of world real GDP may be closer to 2.5 percent than to the three percent projected by the consensus forecast,” Lonski warned.

The second indicator that Lonski sees as pertinent is the U.S. composite high-yield bond spread.

Yield is the current return on a bond. The high-yield bond spread is the difference between current yields of various classes of high-yield bonds (often junk bonds) compared with the yields of investment-grade corporate bonds.

So the high-yield bond spread is very wide currently, Lonski noted, expecting the yield on U.S. Treasury bonds – the favorite safe haven of global investors – to fall.

"The response by bond yields makes sense in view of how U.S. Treasury bond yields serve as benchmark borrowing costs for the world economy. To the degree that industrial metals price deflation accurately reflects a deceleration of global business activity, market forces will drive Treasury bond yields lower in order to limit or reverse such a slowdown," Lonski explained.

“This questions the rationale behind higher benchmark interest rates,” he added.

In other words, global investors should be encouraged to move their funds out of Treasury bonds and into investments that will drive global growth. But this will not happen if the Fed raises interest rates, leading to a better return on safe investments like Treasury bonds.

Lonski concludes that, with an economic slowdown ahead as indicated by the base metals index, and bond yields, raising interest rates makes no sense.

“According to a sample that begins in late 1982, the Fed has hiked rates only once when the base metals price index was down by at least -15 percent year-over-year — and this one exception just occurred at the Dec. 16, 2015 meeting of the FOMC.

Given the way these key indicators are pointing, Lonski forecasts another one will not be coming soon.