U.S. Fed interest rate “crawl-off” not yet fixed for September

July 28, 2015

?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????A U.S. Federal Reserve interest rate hike in September is almost certain according to many forecasters and investors, but the decision to tighten policy for the first time in nearly a decade is not as clear-cut as it may appear.

Leaving aside that just a few months ago most of the same people said the same thing about June, which came and went with no rate rise, any unanimity around such a key turning point for the global economy ought to be extremely rare.

The reality is there isn’t a really durable consensus, and what there is of one appears to be fading yet again.

Some of the top primary bond dealers that do business directly with the Fed, Goldman Sachs, Morgan Stanley and Nomura, along with 11 other banks out of 64 in a recent Reuters poll, say the Fed will wait until later in the year.

Bets in financial markets on interest rate futures are split on a knife’s edge and the dollar’s rally, based in large part on expectations for a rate hike, has paused.

Deutsche Bank’s chief U.S. economist Joseph Lavorgna had this to say to clients: “We still have a September hike in the forecast, but the risks are clearly moving in the direction of a further delay in interest rate crawl-off.”

Slower new job creation and still relatively lackluster pay growth has added to doubts that American consumers, the backbone of the world’s largest economy, are ready for a series of interest rate hikes.

Yet Fed Chair Janet Yellen, who moved away from verbally guiding expected policy timing earlier this year to focus on incoming data, clearly set the stage for a rate hike this year in her testimony to Congress earlier this month.

“If the economy evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the federal funds rate target, thereby beginning to normalize the stance of monetary policy,” Yellen said.

“If we wait longer, it certainly could mean that when we begin to raise rates we might have to do so more rapidly,” Yellen said in response to a question. “An advantage to beginning a little bit earlier is that we might have a more gradual path of rate increases.”

To those hesitating, that probably ought to have provided the necessary push to expect a rate rise this year, and probably soon. After all, she is in charge.

With the Fed meeting to set policy this week, any educated outside observer would be forgiven for asking: if the economy can absorb the first rate hike in nearly a decade eight weeks from now, why can’t it do so this week?

One of the main reasons not to is that this week’s meeting is not followed by a press conference, which would certainly be a useful for trying to explain such a momentous shift in policy and to make sure markets don’t overreact. That also gives the Fed an opportunity at the conclusion of Wednesday’s meeting to give a strong hint rates are about to go up very soon.

Official data on second quarter economic growth due later this week may provide either a crucial barrier or segue to an imminent interest rate rise from the current 0-0.25 percent.

After a 0.2 percent contraction in the first three months of the year, the Reuters consensus is for 2.6 percent seasonally-adjusted annualized growth in the second quarter. A few of the most accurate forecasters expect it to be considerably higher.

“The Fed’s mandate relates to the labor market and inflation, not GDP and inflation, but the GDP data often influence perceptions of the sustainability of labor market improvement,” wrote Jim O’Sullivan at High Frequency Economics. “In turn, a strong bounceback in GDP in Q2 after weakness in Q1 should help the case for Fed action.”

But 2.6 percent growth or even the 3.5 percent forecast by O’Sullivan, the most accurate forecaster on these data over the past year according to StarMine, would not be an exceptionally strong performance by past experience in U.S. recoveries.

Nor would it look any better than this time last year, when the economy contracted by 2.9 percent in Q1, but was then followed by a sharp 4.6 percent rebound in Q2 that subsequently fizzled out. But the Bureau of Economic Analysis may also publish revisions to previous data which some economists think will feed a perception that the economy is on a stronger footing.

A leaked report published on the Fed’s website last week suggested its staff weren’t expecting anything particularly spectacular in the way of growth and suggested only one interest rate hike would be delivered this year.

With no real sign of any meaningful acceleration in inflation — a global force that is worrying most central banks around the world for its weakness, not its potency — the case for a rate rise becomes more difficult to call and hesitation easier to understand.


— with additional reporting by Deepti Govind and Sumanta Dey 

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