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Daily Agenda: The Federal Reserve Decides to Wait

Markets have a muted reaction to Fed’s no-action announcement; KKR energy company files for bankruptcy; China home prices rise; more rumors focus on Malaysia fund.

With no clear consensus among investors going into the Federal Open Market Committee meeting Thursday, it’s perhaps unsurprising that there was no resulting directional reaction among financial assets after the long-awaited announcement arrived. Citing “global economic and financial developments” in a decision to leave benchmark interest-rate targets unchanged, the U.S. central bank’s policymakers sparked a selloff of over 1 percent in large-cap equities with no significant corresponding uptick in implied volatility measures while Treasuries rallied modestly. The clearest signal may have come from commentators who bemoaned months of further speculation about when the bank will finally act. Among these weary voices was a call by People’s Bank of China researcher Yao Yudong for the Fed to provide further guidance to avoid the guessing game leading up to each meeting.

KKR shale oil bet goes sour. On Thursday, Samson Resources filed for Chapter 11 bankruptcy protection. The Tulsa-based oil-and-gas firm was acquired by KKR & Co. in 2011 in a deal reportedly valued at $7.2 billion.

BOJ minutes suggest inflation targets achievable. Minutes from the most recent Bank of Japan rate decision released Friday revealed a consensus among policymakers there that gains in the job market are setting the stage for inflation targets to be reached. According to the document, the central bank officials see a positive trend in core-prices that is distorted by dipping energy costs when aggregated for headline index purposes.

Home prices rise in China. Recent interest-rate reductions intended to calm financial markets appear to have helped property prices, with National Bureau of Statistics data released today showing improvement in 35 or 70 residential markets surveyed in August. The modest rebound helps equity markets on the mainland move higher with the Shanghai Composite Index, closing up by slightly less than 0.5 percent.

Stevens to stay the course. The governor of the Reserve Bank of Australia, Glenn Stevens, testified before Parliament on Thursday stating that he is satisfied with current rates. According to Stevens, regulatory shifts over lending practices and capital levels among banks have offset many of the risks inherent in keeping interest rates at historic lows.

Rumors swirl over Malaysian wealth fund. Further media reports have surfaced over a series of transactions by state-controlled investment vehicle 1Malaysia Development that have resulted in a potential shortfall approaching $1 billion. Unnamed sources cited by the Wall Street Journal stated that officials in Abu Dhabi are investigating a failure by Malaysia’s state-controlled fund to make good on a transfer to an entity in the Persian Gulf state. A series of corruption probes revolving around the fund have focused on the administration of Malaysian Prime Minister Najib Razak in recent months.

Portfolio Perspective: The Fed Faces Dollar Conundrum

The Federal Reserve’s decision to keep policy rates unchanged in September hinged once again on labor market slack and concerns over below target inflation. However, the Fed introduced the recent financial market turmoil and its potential negative impact on U.S. economic growth and inflation as another variable in their decision-making process. FOMC Chair Janet Yellen cited tighter financial conditions since the July meeting as further reason to delay the initial rate hike, most notable among them being wider credit spreads. Investment-grade credit spreads have never been this wide going into the start of a Fed tightening cycle, but one could easily argue that this current monetary policy cycle is without precedent.

In terms of the inflation outlook, the Fed continues to believe diminishing slack in the labor market will drive inflation higher, which is a widely debated topic among macroeconomists, while also stressing the deflationary impact from U.S. dollar strength. What is unclear is how the Federal Reserve plans on hiking rates while risking further strengthening of the dollar and its coinciding deflationary pressure as a result.

Matthew Whitbread is a portfolio manager for Baring Asset Management in Boston.

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