FOMC Preview: Decemberism

After a decline in unemployment to 5.1%, the labor market has shown 'some further improvement' and looking at the employment leg of the Fed's dual mandate, a case can be made for a September rate hike.

However, the Fed is failing on the price stability leg of the mandate with inflation standing at 0.3% and core inflation falling to 1.2%. The concerns about the inflation outlook that existed back in July have risen due to the developments in China in August. Therefore, the doves in the FOMC are not likely to have the 'reasonable confidence' that inflation will return to its 2% target needed for a rate hike this month.

"On balance, while a September hike remains a distinct possibility, we continue to attach a higher probability to a December lift-off. The doves may prefer to wait and see how inflation pressures evolve in the near future and in particular how the Chinese slowdown is affecting the inflation outlook. If the Fed delays the rate hike because of this reason, October should be too soon as well. Therefore, we stick to our long held December call", says Rabo Bank.

Given the absence of wage pressures despite unemployment reaching the Fed's implicit target, further downward revisions of the FOMC's implicit unemployment target is expected in the next 12 months, possibly as soon as this month.

"Given the deteriorating inflation outlook, the absence of wage pressures, and the uneven and fragile economic recovery we expect further downward shifts in the dot plot in the coming years, probably as soon as this month", notes Rabo Bank.