Overnight, the Fed announced that it would keep the target range for the federal funds rate unchanged at 0.25-0.5% for the fifth consecutive time since lifting the benchmark interest rate by a notch in December 2015, which is in line with our expectation. The decision was supported by nine participants, with the only objection coming from Esther L. George of the Kansas Fed.
In the communiqué, the Fed maintained its stance that labour market conditions and inflation would be the two key areas policymakers are focusing on. On balance, the post-meeting communiqué suggested that labour market conditions have improved in recent months, despite worries that arose after the notable decline in job creation in May (see Chart 1). As for inflation, the Fed suggested that near-term inflation should remain low, while the combination of the continual improvement of labour market conditions and the “transitory effects” (i.e. lower comparable base of energy prices) would lead to higher inflation in the medium term. As such, similar to previous communication, it was suggested that, barring unforeseen circumstances, the expected status of labour market and inflation conditions would only support a scenario with “gradual increases” in interest rates.
On the other hand, it also pointed out that “near-term risks to the economic outlook have diminished,” which suggests that there is an increasing likelihood of a rate hike in the remainder of the year. Considering the economic conditions, the change in rhetoric, the occurrence of FOMC meetings for the rest of the year (i.e. 20-21 September, 1-2 November and 13-14 December), and the presidential election scheduled on 8 November – together with the uncertainty associated with it – we believe that there will likely be one more rate hike in 2016 before the Fed will return to an observing mode again.
Given the stability and abundance of liquidity in the Hong Kong banking system (see Chart 2), the direct impact on the Hong Kong economy will be marginal even if the Fed does raise its benchmark interest rate in 2H2016.
Although the aggregate balance – which indicates the interbank liquidity of the system – has shrunk over 28% compared to 16 December 2015 (the day of the most recent interest rate hike), it remains substantial. As such, borrowing costs should remain largely stable at the current level in the near term, which has been the case since December 2015.
To sum up, at this point, the direct impact of a potential rate hike appears to be modest in the short run.
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