Why? Fed officials point to a number of reasons: the unnatural state of a near-zero benchmark rate; the potential risk of financial instability; an improving labor market; diminishing headwinds; and yes, expectations of 3% growth just over the horizon.
Fed Chairman Janet Yellen, usually considered a member of the Fed’s dovish faction, sounded determined to act when she testified to Congress last week. “We are close to where we want to be, and we now think that the economy cannot only tolerate but needs higher interest rates,” Yellen said during the Q&A.
“Needs,” as in the patient needs his medicine. What’s the urgency with an economy chugging along at 2-something percent and low inflation? I suspect Fed officials are terrified of being caught with their pants down, in a manner of speaking.
Should some unforeseen event come along to upend the economy, the Fed’s arsenal would be dry. They’d like to put some space between their policy rate and zero. Sure, the Fed has a balance sheet that can be expanded almost without limit.
But policy makers are the first to tell you they have little experience with the extraordinary measures taken in response to the financial crisis.They’re much more comfortable with an interest-rate tool, preferably set at a level that enables them to engineer a negative inflation-adjusted rate should the circumstances warrant.
Even with several rounds of quantitative easing, no one at the Fed talks about the quantity of money. (Former Fed chief Ben Bernanke even called QE a “misnomer.”)
Nor do Fed officials think about monetary policy the old-fashioned way: the idea that if the central bank puts out more money than the public wants to hold, people will spend it. The goal of QE was to ease financial conditions.
As explained by Bernanke in a November 2010 Washington Post op-ed, the Fed buys long-term Treasuries, which lowers risk-free rates and drives investors into riskier assets: stocks, corporate bonds and mortgage-backed securities.
The rise in stock prices boosts consumer wealth, raises confidence and encourages spending, while the decline in corporate bond and mortgage rates stimulates investment and makes housing more affordable. Mission accomplished?
Last week, Yellen mentioned the situations in Greece (”difficult”) and China (weaker growth, skittish stock market) but neither sounded like much of an impediment to the Fed’s intended lift-off later this year.
She implied that the preconditions for raising rates — further improvement in the labor market and a reasonable degree of confidence that inflation will move back to its 2% objective — had been satisfied.
The labor market continues to send mixed signals: the unemployment rate is at a seven-year low of 5.3% while the labor-force participation rate is near a four-decade low of 62.6%.
And what will instill confidence that inflation is headed back to the 2% target? Signs that actual inflation is heading back to the target.
The personal consumption expenditures price index, the Fed’s preferred inflation measure, increased 0.2% in May from a year earlier. With food and energy excluded, the year-over-year increase is 1.2%. Both measures have shown a pick up in the latest three months.
And Fed officials expect inflation to rise gradually to 2% once the “transitory effects” of earlier declines in energy and import prices dissipate. Oops. Crude oil prices, which seemed to have stabilized following a 60% decline between June 2014 and March 2015, are sliding again on the prospect of Iranian oil entering world markets.
On Monday, U.S. benchmark crude CLU5, +0.16% settled below $50 for the first time since April. And oil is just part of the story. If the Fed is looking for a reason to hold off on a September rate increase, it can look no further than commodities markets.
The CRB BLS spot raw industrial price index, which includes economy-sensitive materials such as scrap metals (copper, steel and lead), rubber and zinc, has taken a dive to levels last seen in late 2009.
The decline in raw materials prices will feed into the prices of finished goods. So the Fed’s confidence in inflation heading higher may be dashed once again.
The Fed scrapped its intended June lift-off because of concerns about the decline in first-quarter U.S. growth. Broad-based weakness in commodity prices is generally symptomatic of weak global demand. If the Fed is at all uncertain about its decision to start normalizing rates, it already has the excuse it needs.
marketwatch.com
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