As I write this today, I am awaiting the Fed’s decision on whether to hike the Fed Funds (“FF”) rate for the first time in almost a decade. The world is watching with what I would call unprecedented attention, but I don’t understand why. Hardly anyone expects the Fed to raise the key rate by more than 0.25%, if at all. The Fed’s target range for the FF rate has been “zero-bound” (0.00%-0.25%) since 2009.
Would a rate hike of 25 bps kill us? I hardly think so. Yet financial markets around the world are poised to react to whatever the Fed announces this afternoon. This is crazy, but it is what it is.
The Fed has made it clear that it intends to “normalize” the FF rate as soon as possible. It has said that its decision will be “data dependent,” meaning it will consider how the economy is doing and how the labor markets are doing. The economy surprised almost everyone by surging at an annual rate of 3.7% in the 2Q. That should certainly be good enough for the policy committee, even though the Fed’s own forecast known as GDPNow stands at only 1.5% for the 3Q.
Likewise, the unemployment rate surprised most forecasters by falling to 5.1% in August, down from 5.3% in July. The jobless rate has plunged from 10% at the end of 2009 to what many, including the Fed, believe is at or near “full employment.”
So with the economy and the labor markets looking pretty solid, the Fed should feel confident that the time is right to initiate “lift-off, right?
Except that there is the issue of inflation, or the lack thereof. The Fed has said that it wants its preferred measure of inflation – the Personal Consumption Expenditures (PCE) Price Index (excluding food and energy) – to be at or approaching 2%. It is not. At the end of August, the core PCE was at just 1.24%
As you can see, not only is core PCE not near 2%, it appears to be trending lower. The same is true for other popular inflation indexes such as the Consumer Price Index (CPI) and the Producer Price Index (PPI).
The headline CPI registered a decline of 0.1% in August and rose only 0.2% over the last 12 months, according to the US Bureau of Labor Statistics. Core CPI (excluding food and energy) rose only 0.1% in August. The PPI (wholesale prices) was unchanged at 0.0% in August and actually fell 0.8% over the last 12 months. Obviously, inflation is not cooperating with the Fed.
Inflation has remained tame this year in part due to plunging commodity prices, including gasoline, and the strong dollar. Given that the economy is near full employment and the dollar has weakened a bit since early August, most forecasters expect inflation to rebound over the next year. That may be true.
Yet that prospect does very little, it would seem, to help the Fed Open Market Committee (FOMC) make a decision to hike the Fed Funds rate today.
Finally, there continues to be talk in some circles that the FOMC might decide today on the date when it will actually announce the rate hike. Put differently, the Committee might announce today that it will raise the FF rate at some specific later date, maybe October or December when the next two policy meetings take place.
I tend to doubt that suggestion, but we’re about to find out.
At 2:00 EDT today, the FOMC announced that the Fed Funds rate will remain unchanged at 0.00%-0.25%. The Committee cited growing concerns about global economic and financial weakness. While the Committee noted in its policy statement that the US economy continues to grow at a modest pace, and the US labor market continues to improve, the members are worried about global concerns, including China.
In addition, the Committee noted that inflation is not near its 2% target, and admitted that if global weakness continues, it could mean inflation could move even lower. The Fed did not give specific guidance as to when lift-off will occur. So, it’s more of the same going forward.
US stocks drifted slightly lower after the rate announcement. The US dollar weakened initially after the announcement.
09-21-2015 6:22 PM
Gary D. Halbert