Fed Chair Yellen must weigh U.S. growth against global slowdown

Federal Reserve Chairwoman Janet L. Yellen, left, is acknowledged by International Monetary Fund Managing Director Christine Lagarde, right, with British Prime Minister David Cameron, during a meeting at the IMF this month.
(Alex Brandon / Associated Press)

Now comes the tough part for Federal Reserve Chairwoman Janet L. Yellen.

After winding down the central bank’s bond-buying stimulus without roiling financial markets, Yellen begins her second year on the job next week with the more difficult task of deciding when to start raising the Fed’s key interest rate, which has been near zero since late 2008.

Her job has been complicated by something she has little control over: the troubled state of the global economy.

She and her Fed colleagues now must weigh improving economic growth at home against a slowdown in much of the rest of the world — a situation that has driven up the value of the dollar and is starting to crimp profits of American companies, particularly exporters.


At the same time, forces overseas have contributed to plunging oil prices in recent months, throwing the economy and Yellen a curveball. While lower pump prices have provided Americans with more spending cash and revved up some businesses, they have hurt energy-producing states and added to the nation’s stubbornly low inflation, which can suppress workers’ pay.

The conundrum was captured in the Fed’s policy statement this week. Policymakers gave a more upbeat assessment of the U.S. economy, noting “strong” job growth, but made explicit mention of “international developments” that could weigh in their deliberations of a rate hike.

Fed officials indicated they wouldn’t raise rates until at least June, but if they wait too long, it could lead to more asset bubbles and financial instability.

Yet moving too soon to tighten monetary policy — as central bankers elsewhere are pumping money into their economies — could upset global markets and thwart what many expect to be the fastest U.S. economic growth this year since the recession.

“I think she did fine as a rookie,” said John Silvia, chief economist at Wells Fargo & Co., expressing a view shared by many analysts and business people. “The bigger challenges are to come.”

When Yellen succeeded Ben S. Bernanke, her principal concern was bringing an end to the Fed’s hefty bond purchases, one of the central bank’s unprecedented actions to spur spending and investment in the wake of the 2008 financial crisis and the Great Recession.

For that, the former UC Berkeley professor and first woman to head the century-old Fed had a blueprint that she helped craft as Bernanke’s lieutenant. Yellen executed it with nary a hitch, concluding the bond purchases in October.

Her one stumble came at her first press conference in March when she implied that the Fed might lift rates six months after halting its bond-buying, a remark that rankled markets globally.


With that plan on track, the main debate inside the Fed’s policy committee was whether the U.S. labor market was strong enough for officials to begin raising interest rates. The Fed has a dual policy: to maximize employment and to maintain price stability.

The global economy, however, has increasingly been creeping into the discussions.

With Europe barely treading water, Japan falling back into recession and the big Chinese economy slowing, forecasters have been reducing growth prospects for the global economy. The U.S. has been an outlier; its outlook has been upgraded in recent months.

One result of this divergent trend is that it has sharply boosted the value of the dollar. The greenback is up about 20% against the euro from six months ago. And American companies are starting to grumble.


Apple Inc., Microsoft Corp. and Caterpillar Inc., among others, have warned that the rising dollar is eating into earnings. Sales in euros look a lot smaller when converted into dollars. The impact can be even harder on American exporters because their products become more expensive in foreign markets.

“Virtually every currency in the world devalued versus the dollar, with the Russian ruble leading the way,” said Jon R. Moeller, chief financial officer at Procter & Gamble Co., which estimated that the higher dollar will reduce his company’s sales this year by 5%.

Should the U.S. raise interest rates, the dollar is likely to get even stronger, said Paul Edelstein, director of financial economics at IHS Global Insight research firm. “If the Fed moves one way and everyone moves the other way, the dollar is going to rise, as we’ve seen.”

The U.S. has a large and, for the moment, growing market for many goods, so the economy may be able to absorb the pinch to exports. But one big side effect of a strengthening dollar is that it will make imported goods cheaper — and that will further tamp down consumer prices.


Inflation has been running well below the Fed’s 2% target, and the recent plunge in oil prices is adding to disinflationary pressures that are making central bankers around the world nervous. Canada and Singapore, whose economies are growing, were the latest to announce an easing of monetary policy in a move to keep inflation from slowing.

Ultra-low inflation could hurt growth, especially wages, and runs the risk of deflation, a dangerous condition of falling prices and wages.

So Yellen faces an improving domestic economy and labor market that argues for a rate hike soon, said Josh Feinman, a former Fed global market economist who is managing director at Deutsche Asset Management.

Yet that decision “could be delayed or swamped by international developments,” he said. “How do you navigate between these opposing forces?”


Yellen has said the Fed was being “very attentive to global developments,” and she has been careful to give as much guidance about future policy changes as possible, mainly to avert criticism that the U.S. was disregarding what its policies are doing to the rest of the world.

Yellen remembers how global markets convulsed for days after Bernanke’s remark in May 2013 of a possible “tapering” of the Fed’s easy-money policies caught investors by surprise.

“They needed to be very clear and transparent, and I think they’ve done that,” said Tim Condon, head of research for ING Financial Markets in Singapore. He doesn’t think global markets will display a similar “taper tantrum” when Yellen starts lifting rates. “They’re pretty well prepared for the liftoff.”

However the world reacts, as with all central bankers, Yellen’s preeminent focus is to watch out for the domestic economy, said Adam Posen, president of the Peterson Institute for International Economics.


“The Fed’s legal mandate is to do its best steering the U.S. economy,” he said, “and except under very rare circumstances, which don’t apply at the moment, that’s the best thing it can do for the rest of the world.”