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The prospect of the US Federal Reserve finally shifting official interest rates higher in the coming months remains a hot topic among investors. While many Wall Street economists forecast a rate rise next month, US markets are showing increasing signs of pushing back on that call.

Whether we see action at the central bank’s mid-September meeting may well depend on how asset prices react in the coming weeks against the backdrop of China’s surprise currency devaluation and growing signs of financial unrest.

While the US central bank has long emphasised that monetary policy decisions reflect the domestic economy, a global situation dominated by slowing growth prospects for China is not being ignored by investors.

A further rise in broad market volatility could well result in the Fed considering whether a rate rise in September is the best course of action.

Nicholas Colas, chief market strategist at Convergex, says a number of US markets are approaching key levels that would suggest the Fed may not follow through with tighter policy next month.

“The jawbone is one of the strongest bits of the human skeleton, and the US Federal Reserve has been hitting capital markets hard with its narrative about raising Fed Funds at its September 16-17 meeting. Now, it appears markets are hitting back,” he says.

China’s currency action this week has fanned global deflationary fears, a trend that the renewed drop in commodity prices during the summer has also suggested.

From the US rate policy perspective, it means watching US crude oil prices, with a break below $40 a barrel in tandem with a further drop in China’s renminbi, not helping the Fed achieve a higher level of inflation over the medium term.

“A move below $40 over the next month is a flashing yellow light for the Fed,” argues Mr Colas.

Also worth watching is the 10-year Treasury yield, which approached 2.50 per cent back in June. Now as global deflationary winds blow, the benchmark is closer to 2 per cent, reflecting how long-term market inflation expectations are also dropping.

Another key plank of the global deflation trade is the value of the US dollar. On a trade-weighted basis, the currency has surged to its highest level since 2003. This has put further pressure on commodity prices and hit emerging market currencies hard, finally compelling China to act this week.

The strong dollar also reflects how the Fed is seen looking to raise rates when many central banks have eased policy this year.

The stronger dollar also helps tighten US financial conditions and has sliced into foreign revenues for many S&P 500 multinational companies.

Given the importance of European revenues for the S&P, renewed strength in the dollar index, which is weighted heavily by the single currency, above this year’s peak bears watching.

That brings us to the state of play for the world’s biggest equity market, the S&P 500.

Having briefly turned negative on the year this week, the bull run that began in 2009 looks long in the tooth, leaving the market ripe for an extended correction.

The benchmark hovers just above a key measure of momentum, the 200-day moving average, with any sustained break of that level representing a bearish signal at a time when the market’s leadership has turned.

Healthcare and consumer discretionary stocks held up the S&P for much of this year, but both sectors have fallen notably during August.

For now the equity market’s barometer of risk appetite suggests all is well.

The CBOE’s Vix index, based on the implied volatility of 30-day S&P 500 options, sits well below its historical average of 20 (since 1990). But should we see the Vix rise above that threshold for an extended period, the Fed may well ease back on its hawkish rhetoric.

Back to the bond market — a crucial barometer of Fed policy intentions is the yield for the two-year Treasury note.

Earlier this month the yield briefly popped above 0.75 per cent, its highest level since April 2011. Any approach of 0.5 per cent in the next few weeks would suggest the bond market is confident a September rate rise is off the table.

Copyright The Financial Times Limited 2017. All rights reserved.
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