Fed indecision throws central banks’ woes into sharp relief

Last week, the US Federal Reserve surprised financial markets by issuing a significantly more dovish-than-expected statement justifying its decision to keep its benchmark interest rate on hold.

Until quite recently, the perception of a strongly dovish Fed would have buoyed equity markets, not to mention emerging markets (EMs) which bore the brunt of a sharp sell-off in the summer of 2013 just after the Fed signalled it would begin winding down, or “tapering”, its quantitative easing (QE) programme.

Yet last Friday, the day after the Fed opted to keep rates on hold, the benchmark US S&P 500 equity index fell 1.6 per cent, while eurozone shares tumbled 3 per cent. The selling continued this week, with the S&P 500 dropping a further 1 per cent between Monday and Wednesday, leaving it almost 2.6 per cent down from where it stood before the Fed decided to leave rates unchanged.

EM currencies, moreover, have benefited little from the Fed’s dovishness - quite the opposite. The Brazilian real and the South African rand, two vulnerable EM currencies, have lost a further 7.3 per cent and 4.6 per cent respectively against the dollar since the Fed’s decision.

Why would the prospect of a delay in the much-feared tightening in US monetary policy spook markets? Futures contracts now assign a less than 50 per cent probability to a rate hike by the end of this year, down from 65 per cent in mid-September.

Partly because of the Fed’s rationale for keeping rates on hold: a significant deterioration in global economic conditions which is exerting downward pressure on an already subdued US inflation rate.