US Fed will struggle to raise rates much in 2016

Subject

US monetary policy outlook for 2016 and its global impact.

Significance

There is a large discrepancy between the US Federal Reserve (Fed)'s estimates for interest rates at end-2016 and the expectations of bond investors. The latter are anticipating less tightening than the 100-basis-point (bp) rise in the Federal Funds rate the Fed has pencilled in for this year. Despite a successful rates 'lift-off' on December 16, the Fed faces many challenges in raising rates in the face of mounting stress in credit markets, disinflationary pressures from the plunge in commodity prices and a contraction manufacturing.

Impacts

• While the Fed will tighten policy, other central banks, including the ECB, will provide further stimulus, accentuating policy divergence.
• Investors will price in a more hawkish Fed if US inflation accelerates faster than expected, potentially leading to a sell-off.
• Concerns about China's economy and the commodity prices slump will also shape investor sentiment.