It was nearly two years ago, March 18, 2015, to be exact when the Federal Open Market Committee (FOMC) dropped “patience” from their policy statement. It was big news. Forecasters, analysts, and the financial media concluded that interest rates in the United States would rise sooner rather than later.
They were bang on, if “sooner” could be defined as eight months. On December 16, 2015, the Fed raised interest rates a quarter point, bumping the target funds rate range to 0.25-0.50 per cent from 0.00-0.25 per cent. They waited another year before raising the target range again.
When rates were increased in December 2016, the Summary of Economic projections dot-plot forecasted three additional quarter-point increases in 2017. Since then, a host of economic data releases point to a U.S. economy that is growing steadily. The latest inflation reading (Feb.15) showed that January CPI rose 0.6 per cent, surpassing the forecast rise of 0.3 per cent. That was enough to boost the CME Fedwatch odds for a March rate increase to 31.0 per cent on February 15.
A couple of Fed presidents may have helped lift the expectations. Eric Rosengren, president of the Federal Reserve Bank of Boston, opined that the Fed may need to be more aggressive than the median Fed forecast. That’s Fedspeak for more than three rate hikes. However, he doesn’t get a vote.
Philadelphia Fed President Patrick Harker does. He repeated his call for three rate hikes in 2017 and earlier in the month suggested that a move in March was appropriate.
Janet Yellen gave rate hawks a Valentine. In her semiannual Monetary Policy Report to the Congress, she delivered an upbeat assessment of the U.S. economy. She pointed out that labour market gains have been accompanied by a further moderate expansion in economic activity and noted that consumer spending has continued to rise at a healthy pace. The comment that set the rate hawks screeching was, “waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession.”
The U.S. dollar soared against the major currencies but slammed into a wall shortly afterwards and retraced all its gains and then some. Traders may not have pachyderm recall but being severely burned on false rate hike hopes does leave a mark. A June rate hike was a sure thing in June 2016, until it wasn’t. The same thing occurred in September 2016. Traders can be forgiven for treating Janet Yellen and her colleague’s statements with a healthy dose of skepticism.
Is this time different? Perhaps. Ms. Yellen testified to the Senate Banking Committee on February 14 that the U.S. created an average of 190.000 jobs per month in the second half of 2016 while the unemployment rate declined to 4.8 per cent. More telling is her comment that unemployment is in line with the committee’s estimate of its long-run normal level. She acknowledged that inflation was rising, although it was still below the Fed’s two per cent objective while ignoring the January CPI report.
She also said at upcoming meetings, “the committee will evaluate whether employment and inflation are continuing to evolve in line with these expectations, in which case a further adjustment of the federal fund rate would likely be appropriate.”
And therein lies the problem. Ms. Yellen and the FOMC have an economy that has fulfilled the committee’s requirements necessary for an interest rate increase. The fact that Ms. Yellen expressed concerns about “waiting too long” suggests that the Ides of March may be bad news for interest rate doves.
But maybe not. The U.S. economy may be growing steadily and employment is close to full but there is a fog of uncertainty rolling in from the White House.
On February 9, President Trump promised “to announce something … over the next two or three weeks that will be phenomenal in terms of tax.” In theory, tax cuts will stimulate jobs and growth and capital expenditures. The issue is with 4.8 per cent unemployment, there is not a pressing need to stimulate job growth. However, the tax cuts could stimulate the economy while increasing inflation.
Mr. Trump is also talking about a 20 per cent “border-adjusted tax” as well as other protectionist trade measures. These trade strategies could have a negative impact on the U.S. economy and offset any benefits from a tax cut.
The economic impact of future tax and trade strategies was cited by Ms. Yellen as an uncertainty. It also provides a tailor-made excuse for an ultra-cautious FOMC to bide their time and wait for further economic inputs.
The FOMC may have lost their patience but they replaced it with forbearance, tolerance and restraint.
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