To my mind, the case for monetary policy tightening in the United State is a “no brainer". So it bemuses me to see in the latest Fed policy minutes the world’s most important central bank is still dithering over when to raise interest rates.
Despite all the hand wringing, however, it still seems likely the Fed will pull the trigger around mid-year. I’m now tipping action at the June policy meeting, which will be the next time (after next month) that Chairperson Janet Yellen is scheduled to give a press conference and present the Fed’s updated set of detailed forecasts. If the Fed does not act then, the next similar opportunity won’t be until September.
Let’s recall: America’s federal funds policy rate remains at the “emergency” level of between 0 and 0.25%, and has been since December 2008 – some six years ago. Since then the economy and stock market have recovered nicely.
The US unemployment rate has been declining for 5 years, and is now lower than that in Australia at 5.6%. In fact, the unemployment rate is only half a percentage point away from what even the Fed considers is the full employment level.
The emergency has passed. And yet the Fed still dithers. Even were the Fed to raise interest rates by 200 basis points, it would still leave rates at quite accommodative levels.
Of course, one of the apparent concerns is massaging financial markets enough so that there won’t be any violent reactions when the Fed finally moves. Yet this seems to be overly cautious – markets are pretty sophisticated and have survived past tightening cycles, albeit with few bumps and bruises.
It’s almost as if the Fed has forgotten how to tighten policy.
Another apparent concern is that inflation remains uncomfortably low, such that there is a risk of a “deflationary trap” should the Fed get it wrong and the economy suddenly falter. Indeed, the consumer expenditure price deflator (the Fed’s preferred measure of inflation) is only up 0.7% over the past year – equal to the lows over the past few decades, excluding the financial crisis. The Fed’s policy target is for PCE to average close to 2% over time.
That said, headline inflation is being held down by falling oil prices. The “core” measure of inflation, which excludes food and energy and is less volatile over time is running at a 1.3% annual rate. While low, it’s only a bit below the 1.7% average core inflation rate since the late 1990s. Indeed, America has enjoyed persistently low core inflation for some time.
Accordingly, I can’t see what all the fuss is about – the US is not Japan or Europe, with solid population growth, competitive markets and good productivity. To avoid raising interest rates because of falling oil prices – which even the Fed concedes is a net stimulus for the economy – is ludicrous.
I remain very confident on the outlook for the US economy – notwithstanding the rising US dollar and some likely cut back in non-conventional oil prices due to weak global prices. As a result, it seems inevitable the Fed will eventually bite the bullet and do its duty to begin the process of “re-normalising” interest rates.
Note, moreover, the Fed will be raising interest rates at a time when the RBA will likely still be under pressure to lower rates due to persistently weak local economic growth and rising unemployment. I’m remain of the view that the long hoped for recovery in non-mining investment will be sluggish, meaning the RBA may well need to push out the anticipated pick up in the economy even further. Based on its action in the past month, this in turn would likely mean further interest rates reductions – one more cut next month to 2% won’t be enough.
