Michael Spencer of Deutsche Bank does not expect Fed to raise rates in August. Fed will look to make the August meeting as data dependent as possible, he says. Therefore he comes to the conclusion, "We expect a 25 basis point rate hike this week, which we think will be the last."
According to Spencer, Fed's concern about credibility on their own forecast leads them to raise rates. Also, Fed will not deliberately overshoot as the view is that they already have, he says.
Spencer says that though there are a few Asian Central Banks like that in Thailand that have overshot on rate hiking, there are also countries like India, Iran and Philipines that have substantial rate hikes left.
Excerpts from CNBC-TV18's exclusive interview with Michael Spencer:
Everybody has got a theory, what is yours?
We expect a 25 basis point rate hike this week, which we think will be the last. We expect the Fed to explain in its post-meeting statement that the risks, going forward, in terms of interest rates are probably evenly balanced between no rate hike and a pause.
Do you expect the Fed to be definitive about that in saying or keeping the door open for a no rate hike or could they be ambiguous, as they tend to be?
I think it will be constructive ambiguity and hopefully not destructive ambiguity. I would certainly not expect as clear a statement as we got, at least temporary from the Bernanke government, that a pause was likely.
The two have tended to bias expectations towards another hike, after the next meeting. We think the Fed will want to change the wording in a way that gives them the leeway not to raise rates depending on the data.
We think the Fed will want to make the August meeting as data depended as possible. Whereas over the last couple of weeks, we have seen the market beginning to price aggressively in an August rate hike, perhaps even later on in the year. We think the Fed will want to try and talk down those expectations.
In terms of data, what do you seem to suggest, will they stop at 5.25% and if they do, you think they are done for the year, or they will just pause in August?
At the moment, our view is that they are done for the year. In fact, for most of 2007, the economy in the US has already slowed down well below the trend and it is not likely to return to the trend growth in the next 18-24 months.
So our view would be one more rate hike. With growth remaining low enough, the Fed would be less worried about inflation going forward. The next change will probably be a rate cut.
We believe in the futures market there is about 12% factoring in almost a 50 bps hike. Any chances of that?
I think it is very unlikely. To throw in a 50 bps rate hike in the tightening sequence this late, would suggest panic on Fed's part, which we
The housing market is clearly slowing down, not precipitously, but it will take-off some of the froth in consumer spending. The labour market has been surprisingly weak over the past couple of months. So a 50 bps rate hike seems out of the question.
Where do you stand for that overshooting argument because that has been the fear that in this run, the Fed may actually overshoot before it pauses and then thinks of cutting a few months down the line? Do you see the risk of overshooting on the part of the Fed?
I think we need to be careful. I do not think that the Fed will deliberately overshoot. However, our view in the sense is that they already have. For more than two years, we were expecting the terminal Fed funds rates to be 5%. So the fact that they were now looking at one more rate hike means that the Fed is probably going to raise the interest rates a little bit higher than they should.
To an extent, people in the markets are beginning to talk about 6% by the end of the year. That would clearly, in our view, be a policy error. I do not think that the Fed views it as a part of their pattern of policy to deliberately overshoot the neutral Fed funds rate.
The risk is that they are concerned about credibility or perhaps less trust or confidence in their own forecast that leads them to raise rates too high. That is a risk, but our sense is that a careful examination of the data over the next six weeks will convince the Fed that 5.25% raise is as high as the Fed funds rate needs to go.
What about the other Central Banks, particularly those in Asia, they are on the curve or a little bit behind it?
I think that it is a pretty mixed bag. We have got a few Central Banks that perhaps are overshooting already. If we look at Thailand for example, they have raised rates fairly steadily and deliberately, more or less in line with the Fed.
For an economy whose growth prospects over the next six-nine months are weaker than in the US, in Thailand, perhaps interest rates have already gone too high.
For other Central Banks including Iran, India and Philippines, they have still got more rate hikes over the next twelve months.
If indeed, the Fed do 25 bps this time around and probably hold out constructive ambiguity, do you think that the markets are ready for a relief rally?
Yes, I think that the tone of the market over the moment is this fear of the excessive monetary tightening in the US, driving global growth significantly weaker. I think that the signal from the Fed that the rate hike in August is not a done deal will be very positively received in the market.
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