Investors seem to expect a continued delay to Fed liftoff

Markets continue to focus on policymakers, particularly with last week’s light roster of data. The debate continues over prospects for Federal Reserve liftoff this year, with Fed speakers continuing to emphasize a rate increase remains likely for this year. However, market prices indicate investors are placing odds at around one in three.

We believe an upturn in inflation data and inflation expectations would likely increase odds of Fed liftoff. U.S. budget and debt ceiling issues are also becoming a factor in the Fed rate decision. The government remains funded until mid-December but the debt ceiling needs to be raised by Nov. 5, according to U.S. Treasury Secretary Jack Lew. The retirement of House Speaker John Boehner at the end of this month and the withdrawal of expected successor Kevin McCarthy from the race is raising risks that either deal will be completed.

Market expectations appear to place low odds that Congress will fail to fund the government or fail to raise the debt ceiling. We would agree, but believe risks to the market remain meaningful, particularly if our concerns are realized.

Economic data outside the United States continues to soften. Purchasing manager indexes generally pointed to slower growth across both developed and emerging economies, including Europe, Japan, and China. Additional quantitative easing in Europe and Japan seems likely to support economic activity.

China returned from a holiday week, trading for the last two days of last week, with markets playing catch up. Data and signals from Chinese leadership will be key, in light of the Fed and market focus on risks from a slower China. China’s 13th plenum, an annual meeting of the China Communist Party’s Central Committee, starting Oct. 26, will provide some indication of longer-term planning as the committee sets forth a new five-year plan. In the near term, markets will continue to watch economic data, as well as currency trends, for indications of policy support to the Chinese economy.

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Robert L. Haworth, CFA, is a senior investment strategist and Darrell Behnke is the Madison market leader for the Private Client Reserve of U.S. Bank.

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