Column: Maybe there won’t be an interest rate hike this year after all
The economic talk in the popular media is still all about the Federal Reserve and the will-they-or-won’t-they decision to raise short-term interest rates.
This rate hike, which is thought by some to be the key to the future course of the stock market, is supposedly imminent before the end of the year. In practical terms that means Oct. 28 or Dec. 16, the adjournment dates of the last two 2015 meetings of the Fed’s rate-setting Open Markets Committee. You can expect reams of news and broadcast commentary aimed at sussing out the Fed’s decision as each of those meetings approaches.
Now is the time for the Fed to do what is often hardest for policymakers. Stand still.
— Former Treasury Secretary Larry Summers
But Fed watchers are becoming increasingly doubtful that a rate hike will happen at all this year, and some doubt it will happen even next year. There are several reasons for the rising skepticism. Here they are:
--First, U.S. economic growth is still not soaring and may already have topped out for the current recovery. Economist Tim Duy of the University of Oregon recently made this case, arguing that “the economy is resting on what is likely its high water mark for growth in this cycle,” with the gross domestic product settling at annualized growth of about 2.5%.
Duy observes that consumer spending, business investment and net exports have all plateaued or turned down, with only government spending showing a consistent (albeit modest) rise over the last year. (See chart below.)
Job growth, which might produce the inflationary pressure that would spur the Fed to act, has been inconsistent and anemic.
--There’s still no inflation. See the graph below, courtesy of economist Brad DeLong of UC Berkeley. “Optimal risk management is to wait until rising inflation is present in the data before beginning lift-off,” DeLong wrote this week. “Interest rate increases in December make no sense, and interest rate increases in March make no sense unless core inflation starts trending up right now.”
--A premature rate hike could undercut the weak recovery. Perhaps the most eminent spokesman for this view is former Treasury Secretary Larry Summers (oft-mentioned as a potential top economic advisor in a Hillary Clinton presidential administration). In early September, Summers cited “a slowing in the U.S. and global economies and reduced inflationary pressures” in arguing, “Now is the time for the Fed to do what is often hardest for policymakers. Stand still.”
At that moment, turmoil in global stock markets had “already done the work of tightening,” he observed. Stock markets have recovered somewhat since then, but not enough to counteract other deadening influences. Summers showed no patience for the argument that the Fed should dip its toes into the rate-hike waters with a pilot increase of 25 basis points (that is, a quarter of a percentage point). “Arguments that the Fed can safely raise rates by 25 BP as long as it’s clear that there is no commitment to a series of hikes are specious,” he maintained. “If as some suggest a 25 BP increase won’t affect the economy much at all, what is the case for an increase?”
--Finally, the Open Market Committee is dominated by “doves.” With a single exception, none is “itching for a rate increase,” as Bloomberg put it last month. That exception is Jeffrey Lacker, chairman of the Richmond Federal Reserve Bank, who has been outspoken in his view that the Fed already should have raised rates. But Lacker’s term on the FOMC ends this year.
Of the other 2015 members, four are neutral on rates by Bloomberg’s reckoning, and six -- including Fed Chair Jane Yellen -- are “doves,” meaning they might be inclined to stand pat unless clear evidence emerges in favor of tightening. (The FOMC comprises all seven Federal Reserve governors plus the president of the New York Fed as permanent members, with the five remaining seats rotating among presidents of the regional Fed banks. Two governors’ seats are vacant, awaiting Senate confirmation.)
Next year, the most dovish FOMC member, Minneapolis Fed Bank President Narayana Kocherlakota, will be retiring and his bank rotating off. Of the newcomers, three are judged by Bloomberg to be hawks and one a dove, but that still will leave the committee in dovish or neutral hands.
For all that, the decision-making on rate increases is dynamic. It’s dependent on trends detected in economic figures, which have been very noisy of late. The decision could also have much to do with a sort of economic politics -- does the Fed want to show that it’s vigilant, or no pushover for the anti-tightening crowd? (That’s the argument Summers tried to debunk.)
Clear signs that the U.S. economy is heating up, even if it shows no signs of overheating, might be enough to push the Fed toward a near-term rate increase. But there could be weakening too. The only thing one can say for certain is that there’s much less conviction that a rate increase is coming this year than there was even this past summer.
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