Will We See A Fed Rate Hike This Year?

joseph-e-meyer225Despite concerns that go hand in hand with persistently low interest rates, such as increased asset prices, the Fed is still unlikely to raise interest rates this year due to the following factors:

Employment levels “not quite there yet”   

Although there has been some mild improvement in the employment figures, we still need to see them return to their pre-crisis levels in order for a rate hike to be safely enforced. The economy is still dependent on the Fed’s support to spur employment to these previous levels, and the employment to population rate, as well as the labor force participation do not warrant a monetary policy change yet.

The wage growth is still weak

Wage growth is still below expectations despite growth in employment. This implies that consumers’ purchasing power is not significantly improving, even seven years after the crisis, during which the economy was supposed to be back on a growth track. A very recent decline in retail sales supports this view. It is still highly risky to raise interest rates at this point, when the economic recovery is still clearly anemic; such move could hamper growth when it is most needed.

The effect of the global economy on the US

The US economy is not immune to fluctuations in the global economy. Although the Fed can raise the rate and induce an artificial balance on the short term, the global markets will eventually set the rate on the long run at zero.

Raising the Fed rate would increase demand on the dollar and thereby raise its value. This would reflect on the US’s trade balance with cheaper imports and more expensive exports, hurting the GDP growth potential. The US should not have an interest in further increasing the value of the dollar as it is already under demand being the international reserve currency and since significant portion of international trade is denominated in US dollar.

Moreover, should the Fed decide to increase the interest rates, the resulting stronger dollar and the capital inflows, would be be more prudently invested in much-needed development projects within the country, a step towards a real recovery of the US economy.

Inflation is still below target

The inflation rate is still way below the level that would prompt the Fed to take action. Currently, inflation stands at 0.9, which is considerably far from the Fed’s  2 percent target. Also, given the slow growth rate in wages and the disappointing decline in retail sales, there is no concern that the mild improvement in employment levels will induce inflationary pressures.

In conclusion

All in all, the above combination of factors will make the Federal Reserve unlikely to increase interest rates next week, in order to avoid halting the already weak recovery. Inflation is a key factor to watch out for, however: When the 2% target is reached, it would send a strong signal to the Fed that the economy is ready to stand on its own.

 

Joseph E. Meyer is a 40-year veteran of the securities industry, and an Arbitrator & Mediator for the Financial Industry Regulatory Authority. He is the publisher of the macro outlook newsletter Straight Money Analysis.com and the director of Meyer & Associates, a Florida based management consulting firm specializing in Arbitration / Mediation.

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