The document summarizes factors contributing to increased volatility in global markets in September 2015, including the potential for the Federal Reserve to raise interest rates. While the US economy has improved, global risks from China's economic slowdown and falling commodity prices pose challenges. It is unlikely the Federal Reserve will raise rates in September due to this increased turbulence, though a rate hike by the end of 2015 or in 2016 is still possible depending on how the global situation evolves.

1. The Global Analyst | SEPTEMBER 201548 |
INTERNATIONAL
I
n these late summer days of
2015 a peak of volatility is
spreading in the global mar-
kets triggered mainly by a
combination of catalysts.
These factors notably include - the
potential decision by the Federal
Reserve (Federal Open Market Com-
mittee), at their Sept. 16-17 meeting,
to undertake either in 2015 or in early
2016 the first rate lift-off since 2006
(monetary tightening); the Chinese
economy slowdown, its highly lever-
aged stock-market bubble and free-
fall (Shanghai Composite Index in
June 2015 was over 5,000 points from
approximately 3000 points in De-
FEDERAL RESERVE’S RATE RISE
Coming Soon?
cember 2014 and now it is back at the
same level it was in December 2014,
that is the index fell by 43 per cent);
and, the impact of the sharp stock
market correction, currency devalua-
tion and massive capital flight (with
potential liquidity risks or currency
wars), the interest-rate cuts and re-
serve ratio cuts, and the below target
GDP growth on the global financial
markets and real economy (i.e., com-
modities, equities, foreign exchange,
credit, financial markets, etc).
Additional catalysts to the current
level of volatility include the sharp
oil prices decline (below $40 a bar-
rel), geopolitical and economic risks
affecting the emerging markets; the
uncertainty about the unravelling of
the Greek crisis (third bail-out in five
years and a new election on the way),
and the ability of China to effective-
ly implement structural reforms to
liberalize its economy and to rebal-
ance its economic model from an
export-led growth (driven by a long-
held investment-and-infrastructure
growth strategy) to a consumption-
led growth.
Lastly, other catalysts are the inves-
tors’ concerns over falling inflation
expectations, and the health of the
global economy (risk of global slow-
down or recession).
In spite of the solid improvement of the US economy fundamentals, it is still unlikely that
a rate rise will occur in September 2015 (unless the Fed aims to make just a minor symbolic
hike), the first one in more than nine years, since it might not be fully consistent with the
current inflation expectations and the latest turbulent international developments.
- Dr. IVO PEZZUTO
Global Markets Analyst, Management Consultant, Economics and
Management Professor
Author of the Book “Predictable and Avoidable” ISTUD Business School and
Catholic University of the Sacred Heart. Milan, Italy

2. 49The Global Analyst | SEPTEMBER 2015 |
Challenges remain
In spite of the above facts, the Fed,
like other central banks, should re-
main independent from political
influence and global externalities,
and it should be mainly focused on
the health of the US economy when
setting its monetary policy, there is
no doubt that in today’s complex,
high interconnected, and globalized
world, it would be difficult for any
central bank not to consider in their
global economic outlook and data
dependent analyses economic and
financial shocks of leading global
economies. The collapsing Chinese
stock markets, the plunging com-
modity prices, and the global slow-
down, geopolitical risks, and the
intensifying currency war will in-
evitably affect, directly or indirectly,
all central banks policies and global
economic growth expectations. The
stock market and credit bubbles
in China, the strength of the dol-
lar relative to th`e emerging market
currencies, (i.e. since 2008 dollar
denominated corporate bonds have
sharply increased in the emerging
markets fueled by massive QEs and
a weak dollar), and the commodity
rout could all affect global earnings
growth. Given the current scenario,
it would be impossible to imagine a
complete decoupling of the Chinese
crisis on the US economy.
The US economy, sooner or later,
would not be able to avoid the de-
flationary forces sparked by the Chi-
nese bubble. In spite of the improving
fundamentals (i.e., economic growth) in
the US economy, the emerging glob-
al risks (i.e., Chinese crisis) are likely
to pose significant challenges to the
economic recovery, sooner or later,
even in the United States, due also
to the strengthening of the dollar
against other currencies which start-
ed in January 2014, when the Fed
signalled that it would raise interest
rates. Moody’s forecast is that the US
growth will be at 2.4% in 2015, before
rising to 2.8% in 2016. Robust job cre-
ation, high corporate profits, favour-
able financing conditions and pent-
up demand all point to higher GDP
growth. (Moody’s, 2015).
The Fed’s recent statement suggests
it expects to raise interest rates some-
time soon and that their monetary
policy tightening will be extremely
gradual. The level of uncertainty
about the Fed’s policy decisions is
contributing to increased volatility
in the markets even though many
sophisticated institutional inves-
tors reported that they have already
priced in the impact of a potential
rate hike (monetary policy normal-
ization) by the end of 2015 or in early
2016. Futures markets indicate that
there is now just a 24 per cent chance
of a rate increase in September 2015.
Since the market currently attach a 24
per cent probability of a rate hike in
September 2015, it is quite likely that
an unexpected decision to start the
first rate lift-off next month might
generate some additional turmoil in
the markets.
Rate rise & its repercussions
Higher rates would raise borrowing
costs for consumers and companies,
possibly hurting spending and eco-
nomic growth. Nevertheless, cur-
rently a large number of economists
expect the Federal Open Market
Committee (FOMC) to raise its target
for the federal funds rate before the
end of 2015. The minutes from the
Fed’s July meeting indicated that the
conditions necessary for an increase
in the federal funds rate “were ap-
proaching” but had not yet been
achieved. A rebound in headline in-
flation and continued solid employ-
ment and overall economic data,
suggest that the Fed might opt for a
first rate hike before end of 2015.
The appreciation of the dollar, the
devaluation of the Chinese currency,
and the further decline of oil prices
are complicating factors in predict-
ing the pace of growth and Fed’s rate
hike decision. The underlying trends
in falling oil prices and falling com-
modity prices have affected infla-
tion rates leading to lower headline
rate of inflation low, while core rate
of inflation (which does not include
food and energy) remains higher.
Household wealth is increasing thus
economists expect that in the coming
months they should choose to spend
instead of saving. In the US economy,
currently, the combination of a low
and on target unemployment rate
and low and below target inflation
rate seem to be related to the par-
ticular national and global economic
cycle highly influenced by falling oil
and other commodity prices, lower
salaries, some structural changes
in the labor market, higher savings
rates, and probably even tightened
lending market conditions.
In light of the most recent interna-
tional developments and increased
volatility on financial markets, many
investors and analysts believe that it
is unlikely that the Federal Reserve
will pursue a rate hike plan in Sep-
tember 2015. Volatility (measured by
the CBOE’s Vix) in the past few days
has surged as high as 53 in intraday
trading (the last time the Vix was
above 20), the highest since February
2009, indicating rising tension across
markets. The S&P 500 nearly dropped
10 per cent. Economists at Barclays
Capital have recently predicted that
rate hike will occur March 2016, stat-
ing that “it is unlikely to begin a hik-
ing cycle in this environment for fear
that such a move may further desta-
bilize markets.” However, given the
fact that FOMC seem to have posed
significant attention on financial sta-
bility considerations, it might still be
possible to effect a first rate hike ei-
ther in September or December 2015
in order to signal confidence to the
markets in reaching the Fed inflation
target in the medium term and the
strength of the recovery.
What the fundaments suggest
Recent data on the US unemployment
rate (at 5.3 per cent) suggests a poten-
tial fall below 5 per cent this year and
a likely need for tighter monetary
policy. Reports show that consumer
confidence rose to its second-highest
level in eight years while new home
sales climbed 5.4 percent, the most in
2015. Good news also came from the
US durable goods orders report. The
New orders for U.S. manufactured
durable goods climbed 2 per cent in
July after jumping by an upwardly
Federal Reserve

3. The Global Analyst | SEPTEMBER 201550 |
revised 4.1 percent in June. Orders
for transportation equipment led
the increase once again, surging up
by 4.7 in July after soaring by 10.7
percent in June. The orders for mo-
tor vehicles and parts jumped by 4.0
percent, while orders for aircraft and
parts gave back ground after spiking
higher in the previous month. Or-
ders for non-defense capital goods
excluding aircraft, a closely watched
indicator of capital spending, surged
up by 2.2 percent in July after climb-
ing by 1.4 percent in June. Shipments
in the same category rose by 0.6 per-
cent in July following a 0.9 percent
increase in the previous month.
Crude inventories fell 5.5 million
barrels in the week to Aug. 21, the
biggest one-week decline since early
June, according to government data
that countered analysts’ expectations
for an increase of 1 million barrels.
Treasuries prices rose after a top
Federal Reserve official scaled back
his view of a rate increase in Septem-
ber in the wake of market turbulence
stemming from worries about Chi-
na’s economy.
The Fed seems not to be in a hurry
to raise rates even though it wants
to get off to zero-bound rates. With
the latest international developments
(the turmoil and volatility spreading
from China to global financial mar-
kets), apparently, the window of
opportunity is rapidly closing for a
Fed’s tightening decision in Septem-
ber 2015. According to the Mortgage
Bankers Association’s (MBA) Weekly
Mortgage Applications Survey for
the week ending August 14, 2015,
mortgage applications increased 3.6
percent from one week earlier. Re-
cent financial market turmoil and
lower price of commodities includ-
ing energy has made it tougher
for US central bankers to go ahead
with a rate hike in immediate policy
meeting scheduled for September
16th/17th.
While survey based inflation expec-
tation has remained stable, market
bases measure has dropped to low-
est level not seen since August 2010,
when financial market was on its
recovery from 2008/09 slump. Infla-
tion expectations as measured by 5
year- 5 year (5y/5y) forward inflation
expectation calculated using swap
dropped to 1.87%, a level not seen in
5 years.
Markit Economics recently released
its preliminary manufacturing pur-
chasing managers’ index (PMI) for
the U.S. The U.S. preliminary manu-
facturing purchasing managers’ in-
dex (PMI) declined to 52.9 in August
from 53.8 in July, missing expecta-
tions for an increase to 54.0. It was
the lowest level since October 2013.
According to survey respondents,
the strong dollar continued to put
pressure on export sales and com-
petitiveness, while heightened glob-
al economic uncertainty appeared to
have dampened client spending both
at home and abroad. Alongside this,
manufacturers of investment goods
widely cited growth headwinds
from the slump in capital spend-
ing across the energy sector. Rise in
global volatility has pushed inves-
tors to the safety of treasuries, which
has pushed expectations of inflation
down.
Fed policymakers are still concerned
about the weakness of the global
economy, but they are also more con-
fident about US growth prospects.
Developments in the world economy
and commodity markets have in-
creased the downside risk in achiev-
ing the sustainable inflation path to-
wards 2 percent, thus an immediate
monetary policy tightening by the
Fed might probably affect markets
across the world and might cause
more pain for emerging market as-
sets, already being hit by China’s
woes. If US tighten their monetary in
such timing, a correction in the stock
market probably can’t be avoided.
Rate rise can wait
To conclude, in spite of the solid im-
provement of the US economy fun-
damentals, it is still unlikely that a
rate rise will occur in September 2015
(unless the Fed aims to make just a
minor symbolic hike), the first one in
more than nine years, since it might
not be fully consistent with the lat-
est turbulent international develop-
ments. It is more likely, instead, that
it will occur at the end of 2015 or in
2016 if the emergency phase of the
Chinese crisis will soon resume and
if the US economy will not have an
unexpected overheating in the com-
ing quarters.
Naturally, the S&P 500 index would
be highly energized, at least in the
short-term, by a decision of the Fed-
eral Reserve to delay the Fed’s inter-
est rates lift-off in September 2015
and by a firm commitment and a
coordinated effort of central banks
to continue to flood the markets with
further monetary stimulus (i.e. stir-
ring markets’ QE addiction) in order
to avoid deflationary trends and fur-
ther global economic slowdown.
Federal Reserve
TGA