United States: Federal Reserve interest rate hike not guaranteed in 2015
October 23, 2015
Market analysts are struggling to determine whether the Federal Reserve will hike rates this year or postpone a move until 2016. There is ongoing uncertainty regarding the Fed’s plans for raising the federal funds target rate, which has been kept at a historic-low range of between 0.00% and 0.25% since just after the global financial crisis hit in 2008. The stage for a rate hike appeared to have been set a few times already this year amid steady improvements in several areas of the economy, but the Fed has repeatedly refrained from making a move. Worries that a premature rate hike might derail a recovery that has taken years to solidify, persistently-low inflationary pressures, and more recent concerns about the impact that a slowdown in emerging markets and financial market volatility could have on domestic growth, have prompted the Fed to postpone a rate hike. Analysts have not ruled out the possibility of an initial rate hike being made in December, although disappointing domestic data, unsettling global developments and a lack of consensus among the Fed’s committee members make it exceptionally hard to predict whether this will happen this year or if a rate adjustment will be pushed back to 2016.
Minutes from the Fed’s 16–17 September policy meeting and recent public statements by Fed officials reveal that there is still concern about the health of the economy and no solid consensus within the committee about the appropriate timing of a rate hike. Latest data show that inflation is far from taking hold, and it is unlikely to do so as long as energy prices remain in check and the dollar stays strong. Some Fed officials have expressed concern that hiking too early could create a deflationary price environment that would be hard to correct later, while others have noted that waiting too long may not only drive unwanted inflation but also fuel the buildup of imbalances in the financial system. Moreover, even though the employment rate is down to pre-recession levels, payroll and wage growth figures are far below the desired level, and there still appears to be some slack in the labor market. Furthermore, it remains to be seen what the spillover effects of slower growth in China and other emerging markets will be.
While the Fed ultimately voted 9 to 1 to keep rates unchanged in September, the meeting minutes reveal internal debate and recent statements show a mix of opinions about whether a rate hike will happen this year. One major issue at this juncture is whether the factors that prompted the Fed to hold in September will have faded sufficiently to warrant a hike before the end of the year. Lewis Alexander, U.S. Chief Economist at Nomura recently commented:
“Of course, the minutes reiterate the judgment that the Committee “expects” to raise rates this year. That said, it is not obvious how quickly the doubts that caused the Committee to stay on hold at the last meeting will dissipate. The data released since the meeting – strong auto sales in September, weak trade data for August, declines in business surveys, and a weak employment report for September – have not settled the questions that the FOMC’s doubts about the outlook. In this context we continue to believe that an interest rate increase this year is not the most likely outcome. Rather, we now think liftoff will come at the March 2016 FOMC meeting.”
While questions about the timing of a first hike remain far from answered, the one thing that seems certain is that the pace of rate hikes will be very gradual once normalization begins, such that the current accommodative monetary environment will remain in place for at least a couple of years. Finally, several analysts have emphasized that the Fed has done a poor job of providing clarity about its plans and that its credibility will be at stake if it waits to increase rates until 2016.
Author: Carl Kelly, Economist