Weekly Risk Outlook

Weekly Risk Outlook
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US FOMC meets to set interest rates. Brazil likely to raise interest rates again as economy tumbles. Mexico’s interest rate decision reflects thoughts on US Fed. Japan’s cabinet holds conference on economic development. The US House prepares for August recess as Senate scrambles on highway spending. All in the Weekly Risk Outlook.

Federal Open Market Committee Meets to Set Interest Rates

On Tuesday the Federal Reserve’s FOMC will meet in a two-day meeting to set federal U.S. interest rates.

It is highly unlikely that the Fed will raise interest rates this month, though an interest rate hike within the next six months is increasingly likely.

Growing consensus among economists has converged on the notion that the Fed will raise the Federal funds rate in September, and Federal Reserve Chair Yellen’s comments last week to the House Financial Services Committee support that the Fed will likely raise interest rates in 2015.

Conversely, market watchers have converged on the notion that interest rates will be raised in December or even later. However, any significant market reaction following a September (or December) rate hike will likely be tempered by future actions from the Federal Reserve.

While most expect a 25-basis point increase in the currently near-zero rate, the Fed has given no indication that it will work to quickly ratchet up interest rates. In fact, Fed Chair Yellen has repeatedly stressed the opposite: interest rates will likely increase at a very gradual rate to prevent significant market shocks or disruptions.

Brazil Likely to Raise Interest Rates Again as Economy Continues to Tumble

On Wednesday, the Brazilian Central Bank will meet to discuss interest rates, currently resting at 13.75%.

Brazil has raised its interest rate metric for seven months in a row to stave off an emerging recession and increasingly dire forecasts for growth this year.

The Central Bank will likely increase interest rates again this week, possibly as high as 14.5%.

The rise in interest rates has been a long-term attempt by the Brazilian Central Bank, working in concert with the national government, to stave off one of Brazil’s traditionally nastiest economic bugbears: inflation.

However, this appears to be an increasingly losing battle. Economists increased their inflation estimates last week to 9.15% and reduced their growth forecasts for the year to a predicted contraction of 1.7%. Unemployment in Brazil also rose for the 6th straight month, now at 6.9%.

One bright spot for the country? Last week Brazil’s mining company giant Vale reported a 7.4% increase in iron production from the previous quarter, despite a fall in most commodities prices.

Mexico’s Interest Rate Decision Will Reflect Thoughts on U.S. Fed

On Thursday, the Banco de Mexico will decide whether to raise Mexican interest rates. For the past nine months the central bank has kept interest rates at 3%, in stark contrast to Latin America’s largest economies, though largely in line with other Pacific Alliance countries.

Mexico is the Latin American economy most integrated with the U.S. economy. As such, the U.S. Federal Reserve’s interest rate decision is of particularly strong importance as Mexico has the most to lose by a U.S. interest rate hike.

Even if the United States Federal Reserve chooses not to raise interest rates this month (which it almost certainly will not), a decision by the Bank of Mexico to raise its own rates this week would represent an important bellwether signal that other countries are taking the possible rate hike by the Fed very seriously.

Unlike Brazil, which raised interest rates several times and is likely to do so in the coming months to stave off creeping inflation, Mexico has maintained very low inflation levels and in fact reached a record low 2.76% inflation rate last month.

As a result, a decision by the Mexican central bank to raise interest rates with record low inflation levels (making an interest rate rise less manageable even as the Mexican peso falls against the dollar) would indicate the significant impact a Federal Reserve decision is perceived to have on Mexico’s competitiveness in the U.S. market.

Japan’s Cabinet Holds Conference on Domestic Economic Development

On Friday, the Japanese PM Shinzo Abe’s Cabinet Office will hold a conference to discuss Japan’s growth potential for the coming year. The event will be attended by senior economic policy advisers to Mr. Abe, as well as several IMF personnel and the president of the Japan Center for Economic Research, Kazumasa Iwata.

Economic figures in Japan have improved recently. In June, the Cabinet Office noted that first quarter annualized growth for 2015 was 3.9%, well in excess of the 2.4% growth estimation from 2014. However, many market watchers noted a fall in industrial output and consumer spending, likely foreshadowing a sharp reduction from these rosy figures in the next few economic quarters.

The reduction in output and spending likely contributed to the IMF’s recent warning to Japan that the economy will likely not grow strongly in the medium term (noting Japan’s aging population as a continuing drag on growth potential).

This IMF warning followed Mr. Abe’s 3-year economic plan announcement, which forecast strong growth rates and included no fiscal policy tightening for at least the next three years.

The IMF recently raised its World Economic Outlook forecast for Japan’s growth rates from .8% to 1.2%, though the higher growth rate will not be enough for Mr. Abe’s plans to reduce Japan’s enormous debt burden (246% of GDP) without increasing tax obligations.

US House Prepares for August Recess as Senate Scrambles on Highway Spending

The U.S. House of Representatives is slated to end its legislative session on Thursday for the August recess and will return for its first full day of legislative session on September 8.

The Senate is slated for a departure the following week, yet on one issue the House departure date is far more pressing. On July 31, the United States Highway Trust Fund will run out of funding if Congress does not reauthorize the Fund, either in a short term extension (as has often been the case) or a longer-term measure.

The House has already passed its own $10.9 billion highway bill (the final tally was 367-55), using revenues from a variety of unique sources and with strong support from both Democrats and Republicans.

Historically, the federal gas tax (currently 18.4 cents per gallon) had paid for transportation infrastructure but, as the tax has not changed for 22 years, it cannot meet U.S. infrastructure needs. The Senate has decided to pursue its own measure this week, negotiated by Senate Majority Leader McConnell (R-KY) and liberal Democrat Barbara Boxer (D-CA), that would extend the Highway Trust Fund for 6 years.

The Senate bill, to the chagrin of conservative Republicans in both houses, will likely include an amendment to reauthorize the Export-Import Bank of the United States, which would slow down the legislation particularly in the Senate. Given the planned departure of the House on Thursday, the Senate will need to consider, debate, amend, and finally pass a multi-billion dollar, 1,000+ page bill, and then send it to the House in less than a week.

Both House Democrats and Republicans have already indicated opposition to the Senate measure for a variety of reasons.

Though Senate passage of the massive bill is possible, it is far more likely the Senate will ultimately pass the much smaller House version and negotiate a 6-year deal after the Congressional recess.

 

The GRI Weekly Risk Outlook (WRO) provides analytical foresight on the economic consequences of upcoming political developments. Covering a number of future occurrences across the globe, the WRO presents a series of potential upside/downside risks, shedding light on how political decisions affect economic outcomes. 

The Weekly Risk Outlook is written by GRI analyst Brian Daigle.

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