The Next Hollow Idea of the Fed

The Chairman of Federal Reserve Board, Janet Yellen, recently aired her idea of a “high-pressure economy”. She stated that this kind of economy would reduce the jobless rate and permit inflation to run hotter than the set goal.

Yellen has sent the minds of investors reeling. This new addition to the monetary policy quiver, delivered in a speech at the Boston Fed, has resulted in worries that the Fed may allow the economy to overheat.

The chief investment strategist at Wells Capital Management, Jim Paulsen, thinks it is a risky concept. He stated that the Federal Reserve has accepted a “lower-for-longer position” with interest rates. The Fed has a dual mandate: it intends to maintain a full employment level of 4.8 per cent at 2 per cent inflation. In a high-pressure economy, the jobless rate would be allowed to drop below the full employment level. This raises the concern that it might be hard to control a this type of economy. In other words, keeping interest rates too low for too long could allow inflation to get out of hand.

A strategist at Prudential Financial has questioned why the Fed has been telegraphing a rate hike. He believes Yellen has plans to introduce a rate hike for a different reason. The Fed is famous for introducing a dovish slant on rates. However, it is confronting a minority bloc on the committee that is keen to witness a rate-hiking cycle. The talks surrounding a high-pressure economy have created fears in the minds of investors. Fed policies have been the cornerstone of the bull market as well as the center of economic recovery. Whatever the case is, it would be economy that would be hard to control.

With the Fed’s last meeting for 2016 scheduled, the stage seems to have been set for a hike in the interest rate. During a statement released in November, the Fed’s policy committee stated that the case of higher borrowing costs has strengthened, owing to a pick-up in inflation. There is a 76 per cent probability for a rate hike by the year-end as per data compiled by Bloomberg.

However, some strategists believe Trump’s victory in the presidential elections could result in aflip in the situation. Trump has accused the Fed of indulging in politics during the election campaigns.

With Trump getting elected, the rate-hike probability may shoot up by 20 per cent. Financial conditions can tighten which can impact the growth negatively. The Fed needs to wait and watch how things would proceed now. Four rate hikes were predicted by policy makers during 2016. However, they have remained stand pat even amid signs of decline in global growth. Dennis Lockhart of the Fed Bank of Atlanta signaled that the central bank is on track when it comes to raising rates during the next month. However, he has also hinted that the officials may be prevented from pulling the trigger due to some event risk. He stated that there persists a high bar in economic terms. As per the domestic economic data, the Fed needs to raise rates during December. With Trump’s victory in the presidential elections, a more uncertain environment has been created as per a rate strategist in New York. The Fed needs to watch and wait to see how things unfold before introducing a rate hike.

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