To hike or not to hike and why should you care?

Next week the Fed will decide whether or not to hike rates for the first time since June 2006. Polls by Reuters and Bloomberg show that the vast majority of market participants expect a rate hike. Any remaining doubt was erased by the positive jobs numbers a week ago. But every time there's a strong consensus about something, there's a chance for a big surprise. 

Janet Yellen, Chair of the Board of Governors of the Federal Reserve System. 

The Fed has a dual mandate, which we are reminded of every time Janet Yellen gives a public speech or testifies in Congress. The mandates are 1) stable prices and 2) maximum employment. Officially all Fed policy changes are dependant on data regarding 1) and 2). However, many market observers (myself included) believe there are other key drivers as well, such as US stock market development and external value of the USD. These suspicions are always denied by the Fed, though they might admit that they are “closely monitoring” some development.

If there's going to be a big surprise next week, it will require a major and sudden change in one of the (official or unofficial) indicators the Fed is looking at. The obvious candidate is the stock market, where we on Friday the 11th saw a major sell-off both in Europe (DAX -2,44%) and in the US (S&P500 -1,93%). Volatility as measured by the VIX spiked too. Should this sharp global sell-off continue early next week the Fed might reconsider its rate hike plans. They would of course never admit that stock markets influenced their decision making. Instead they would cite low inflation numbers or feed us some mumbo-jumbo about “persisting slack in the labor market”. 

Now why should you care about the Fed’s announcement on Wednesday the 16th? Moreover, why should you care if you live in Europe? The answer is simple. For many years now the financial markets have been totally driven by central bank policies and the Fed is the most important central bank in the world. In other words, central bank decisions and actions determine to a large degree how and where capital flows in the global markets. Not an entirely healthy situation, but that's how it is, and the decision to end a seven year period of abnormal zero interest-rate policy is a really big decision. Like it or not, the way capital flows between asset classes globally has an impact on all economies. In the end it will affect you too, sooner or later and no matter what you do for a living. No wonder Janet Yellen is considered to be the world's seventh most powerful person.