Fed “post-Brexit”: Any further tightening may not now happen until 2017 - ING

Rob Carnell, Chief International Economist at ING, notes that the UK referendum on continued EU membership has voted “Leave” in a close vote of about 52% for leave vs 48% for remain.

Key Quotes

“With financial markets already reacting to this result and the trade-weighted dollar appreciating sharply, we see the chances of a Fed hike this year as slipping away.

Our view on the likely timing of the Fed’s next rate hike has always been contingent on a “Remain” vote in the UK, since one of the three conditions we believe the Fed views is necessary for a further hike (our “trifecta”) is financial market stability. We believe US financial market tightness will increase significantly following the UK’s “Leave” vote, irrespective of what is happening elsewhere in the US economy.

Moreover, although the uncertainty of the UK’s EU membership vote is now behind us, the uncertainty of how this will proceed is now a real issue. Messy politics in the UK, and an uncertain reaction from the EU in terms of how to treat a departing member, all make for a period of heightened risk aversion.

The USD is one, but not the only, currency seeing safe-haven flows following this event (the JPY will also likely see strong inflows). And with the USD trade-weighted index likely to strengthen in coming weeks and months, US financial tightness is likely to increase, adding a further impediment to any thoughts of near-term rate hikes.

Besides Financial market tightness, the other legs in our “trifecta” are labour market/economic activity strength and the direction of inflation.

It is just possible that these other two legs could be sufficiently strong to override any lingering financial market tightness. But we see this as highly unlikely. For one thing, a stronger USD will likely have a knock-on effect in terms of economic activity, with the manufacturing/export sector likely to see recent improvements curtailed.

Furthermore, lower import prices following dollar strength will weigh on headline inflation, and we may also see dollar-based commodity prices slip again on any dollar gains, undermining the prospect of a base-effect-led increase in headline inflation rates.

In any case, it would have taken exceptional outperformance in the two other legs of our trifecta for the Fed to ignore financial market tightness, and we just do not see this as realistic.

Consequently, any faint prospect of a July hike has now entirely vanished, though that was looking fairly remote anyway. Our long-standing September rate hike call also looks to be hanging in tatters following the Brexit vote. And with the US Presidential Elections in November all but ruling out a November rate hike decision, this only leaves the December FOMC meeting as a possibility. Even this will need some further clarity on the UK’s path to a future outside the European Union to be known, and financial markets to have responded by calming down and unwinding some of the safe-haven flows that we now expect to dominate markets in coming weeks and months.

Put like that, even a December hike looks a long-shot, and any further tightening may not now happen until 2017.”