Déjà vu? Fed may struggle to hike if U.S. optimism fades for H2

April 28, 2015

RTR4VVNE.jpgThe U.S. Federal Reserve may find it even more tough to raise interest rates as the year wears on if dwindling expectations for growth are any guide.

Already-fading expectations for economic performance have distinct echoes of most years since the depths of the financial crisis six years ago.

The difference this time is that the Fed is no longer stimulating the economy by printing billions of dollars of money through bond purchases. And the dollar has risen as much on a trade-weighted basis since last summer as it might normally do over most of an entire economic cycle.

What is no secret to financial markets or the Fed, which is meeting to set policy, is that the year has had a dismal start. So much will depend, as in previous years, on how quickly the situation improves.

The U.S. economy is likely to have only grown just 1.0 percent on an annualized basis in the quarter ending March according to the latest Reuters poll. The range of forecasts was 0.2-2.4 percent.

Just one month back, the consensus was more than double that, at 2.3 percent, with a much wider and more optimistic array of views, 1.0-4.0 percent.

While much of that is down to yet another bad winter and a seize-up in West Coast port trade, the worry is that every time growth falters in the first quarter, there is a sigh of relief as it bounces back again in Q2, engendering a bout of optimism that eventually fades away as the year progresses.

The latest read on U.S. consumer confidence, which undercut even the most pessimistic forecast in a Reuters poll, won’t help on that front. 

A look at the top end of forecasts from the latest Reuters long-term economic outlook poll shows a worrying pattern: Q1 tops out at 2.4 percent (down from 4 percent), Q2 is at 4.8 percent, Q3 at 4.1 and Q4 at 3.8. Medians show the same trend on a less exaggerated scale.

US GDP

Philip Marey, economist at Rabobank said:

It’s a very strange thing that we seem to go through every year: there’s a lot of discussion about what the cause is, and it’s not clear what’s behind it.

But if that’s a general trend, the negativity is being reinforced by the strength in the dollar.

The soaring greenback has caused plenty of concern. Indeed, the majority of economists polled by Reuters this month on the big picture said it was the biggest risk to economic growth this year.

The effects in the real economy are already clear. U.S. company profits have been falling, with many choosing to buy back shares as a short-term boost rather than investing for the future. That could be exacerbated if an eventual interest rate hike sparks even further dollar appreciation as markets price in follow-up moves.

Marey added:

This will make it more difficult for them to go ahead with it — they will certainly not do it in June.

What happens is they usually get scared of their own shadow, like what happened with tapering — they saw higher long term interest rates, higher mortgage rates, a slowing housing recovery and they backed down.

The current expected bounce-back in growth in Q2 may give the Fed enough ammunition to hike rates in September, especially if it drives up what has been so far an elusive increase in wages and inflation. Yet while most forecasters see rates rising in September, nearly two-thirds of them say that the economy won’t grow any faster in 2016 than it will this year.

That suggests at very least that there will be no rapid succession of rate rises, as the Fed has been saying all along.

Goldman Sachs economists wrote:

We expect a below-trend pace of GDP growth in Q1. Nonresidential structures will probably post a substantial decline, reflecting falling oil industry capex. Net exports, too, will likely be a drag on growth during the quarter. However, much like the pattern seen last year, we anticipate a bounce-back in growth during Q2.

The top end of growth forecasts for 2015 has been falling as well. Two months ago, the range was 2.5-3.9 percent. Last month, it was 1.9-3.7 percent. Now it’s 2.2-3.6 percent.

There’s quite a lot riding on hopes for a recovery in the second half. But if 2015 is another case of déjà vu, the Fed may find it increasingly hard to raise rates.

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