1.  Temporal Inconsistencies at the Fed:  The Fed’s decision to delay the beginning of the normalization of monetary policy of undermines confidence in when lift-off will actually take place. It is clear that many, like ourselves,  who thought September was a likely opportunity, have now pushed lift-off to December, largely skipping the October meeting due to its proximity and the absence of a scheduled press conference. In recent months, the FOMC has recognized that market-based measures of inflation expectations were soft but that survey-based measures were stable. Last week the FOMC singled out the softer break-evens as part of the justification to wait before hiking.  

Similarly, the Fed seemed to give more weight to international variables than seem warranted. That China’s economy is slowing is hardly news.  Few, if any, believed that it was growing as fast it claimed.   When the Fed met last week, the S&P 500 had retraced more than 60% of the decline, ostensibly inspired by the turmoil in China. The MSCI EM equity index was nearly 10% off the lows it had seen on August 24.  

That said, the shift in the reaction function is not unprecedented.  We recall that many had expected the Fed to announce tapering of QE3 in September 2013.  Instead, perhaps spooked by the earlier taper tantrum, the Fed waited until December.  Some, who see the Fed waiting until next year, see year-end market conditions deterring it, but this does not seem like a significant obstacle.  

2.  Divergence Meme Alive and Well: The dollar bull narrative we have sketched out was never predicated on the precise timing of the beginning of the normalization process of Fed funds.  It was based on the divergence of the trajectory of monetary policies.  Since the end of QE3, the divergence has been driven by other central banks. This may continue to be the case a bit longer, so it appears. 

The appreciation of the euro on a trade-weighted basis and the drop in oil prices has seen senior ECB officials emphasize the flexibility of its asset purchases program. This week the ECB offers its fifth tranche of TLTRO funds. The cumulative total of the first four tranches was a little more than 384 bln euros. Another 50-70 euros are expected be drawn this time.  Japan may report this week that its core measure of inflation (excluding fresh food) fell back into negative territory in August for the first time since April 2013.  This will likely boost speculation that the BOJ will have to expand its already aggressive unorthodox monetary policy.   There is a good chance that Norway’s central bank cuts its deposit rate by 25 bp to 0.75, though the Bloomberg consensus favors a stand pat stance.  

A number of other countries, including Sweden, Switzerland, Canada, Australia, and New Zealand can still ease monetary policy. With high real rates and 18% reserve requirements, there is still scope for China to ease monetary policy.  Several emerging market central banks meet in the week ahead (Columbia, Mexico, Hungary, Turkey, Nigeria, South Africa, Philippines, Taiwan, and Israel).  Israel is the most likely candidate to cut rates. A 10 bp rate cut would bring the base rate to zero.