Today is the second day of the Federal Open Market Committee meeting after which the decision will be announced on monetary policy. There is an overwhelming expectation that the Fed will not move on rates today. There are several practical reasons why not, most notably the lack of economic forecasts and a press conference. However there is also a large body of thought that is convinced there will be a rate hike in the coming months, maybe even in September. The Fed will stand pat today, choosing not to engage its first move on interest rates for six years. So if not today, then when will the first change be?
I am not in the camp of those analysts/commentators that believes the conditions need to be perfect for the FOMC to hike rates. Monetary policy is a forward-looking business. The decisions made today are taken with a view on what inflation and unemployment will be looking like months from now. It cannot be a reactive move, it needs to be proactive, otherwise you run the risk of being behind the curve (some might even argue that the Fed is already behind the curve now).
The “emergency” level of interest rates has been in place for over 6 years now. Unemployment is back at 5.3% which is around half the level it reached at its peak in 2010 at 10.2%. Core inflation is stable even if it is not picking up. Despite last month’s disappointing dip, Average Earnings Growth has threatened to pick up from its long time average of around 2.0% (increasing earnings should arise from unemployment moving towards a low level and this should help to drive core inflation).
Emergency level of interest rates should be used in times of economic emergency. This is not such a time anymore. The US has been a leading light in holding up the global economy now for several quarters. There are significant problems that arise from holding rates at record lows for too long without looking to normalise them again. Financial markets mis-price risk, “zombie” companies limp on using up valuable resources that could be better deployed in economically constructive hands (the law of creative destruction), whilst it also restricts the options of the Fed to use monetary policy should recession hit once more.
The Fed will not move on rates this month because:
- It would want to see the Personal Consumption Expenditure data picking up on Monday
- It would want to see the Average Hourly Earnings rebound again in Friday’s Payrolls report
- It will want to wait for the analysis of the most up-to-date Economic Forecasts (due in the September meeting).
What could be key for the Fed’s view is the Jackson Hole Economic Symposium (27th to 29th August). This has been an event where historically there have been a number of crucial Fed monetary policy moves touted in the past.
However, despite all of my arguments, there are also several issues why I also do not believe that the Fed will move in September either. The steep fall and bear market in commodities in recent week is deflationary and falls in the prices of oil and metals will keep inflation anchored. Furthermore, the consumer indicators are still disappointing. Retail Sales disappointed recently, whilst Durable Goods Orders remain depressed and Consumer Confidence had a significant slide yesterday.
Furthermore, the inherent make up of the FOMC members makes the committee a cautious body. Whilst there may be rhetoric of members such as James Bullard (non-voting) and Dennis Lockhart (habitual hawk anyway), the balance of the committee are still dovish by reputation – not the least of all being Janet Yellen. With October also being without a press conference or Economic Forecasts, I expect it to be December. I think that by that stage the FOMC will also be in the mind-set that they will have to move now, otherwise it would send the market a very worrying message.
The conditions will never be perfect for the first rate hike, but I believe the Fed will not move today, they will bottle it in September and then have to move in December.