The Fed shouldn't even be thinking about hiking
A majority of FOMC members want to hike today but when it comes time to decide they won't have the nerve to do it. That's the right decision but here are three reasons why the could make a big mistake and hike rates. We'll also look at what happens in markets if they do.
1) Markets have calmed
Yesterday, the S&P 500 rose to the highest since the mini-panic started. The Fed could take that as a sign that markets are ok with a hike and that everything is fine in the global economy. Rather, it's a sign that markets feel they've sent a strong enough message to the Fed not to hike.
2) The Fed is overly focused on the domestic economy
The Fed believes the economy is growing, jobs are plentiful, consumers are confident enough to borrow and spend more and that will lead to inflation in 6-12 months. They're myopically focused on domestic economic data and not recognizing the headwinds from a slowdown in global growth and a strong dollar. That pain and disinflation is just starting to hit manufacturing but it will spread.
3) The Fed thinks it's omnipotent
There are some people in the Fed - including Yellen -- who are under the illusion that a rate hike will be seen by the public and markets as a sign of confidence in the economy. It won't be. It will be seen as a grave policy mistake and undermine the market's confidence in the Fed for months.
What happens if the Fed hikes
First, it will hit equities hard.
The kneejerk will be to buy the US dollar but the kneejerk won't extend in trades like EUR/USD, USD/JPY, USD/CHF and perhaps GBP/USD. It will quickly retrace in the yen trade as risk aversion sets in.
The commodity currencies are the most vulnerable. Neighbouring CAD will sink.
Overall, this is a bit of simplistic analysis because the communication, Yellen's press conference, the forecasts, the dot plot and everything works together to leave a nuanced impression.
For more on the Fed, check on Ryan's excellent preview.