Fed’s Indecisiveness to raise interest rates
The recent market volatility seems to be unrelated to the growing recovery and stability of our economy. I wonder if the Federal Reserve should have clearly explained why they might increase short-term interest rates to achieve their objective of managing our economy.
To stimulate the economy during periods of recession, the Fed lowers interest rates to encourage borrowing and spending. When the economy heats up and inflation increases, the Fed raises interest rates to discourage borrowing and reduce inflation. Our former Fed chairman outlined a range of target interest rates and inflation that would trigger such policy changes. It was objective, understandable, and predictable. However, the recent deletion of the word “patient” from their statement about when they would begin to raise interest rates inferred that an increase was imminent, and that contributed to unnecessary market volatility.
Actions in Europe are causing further confusion because their economy is where we were a few years ago, in recession. The ECB (European Central Bank) is following our strategy of quantitative easing to lower interest rates and stimulate their economy. Their currency declined in value resulting in close to parity with the U.S. dollar. These diverging economies are causing a reversal of fortune for our countries. The attractive exchange rate allows U.S. importers and vacationers in Europe to buy foreign goods at a big discount. However, U.S. exporters are suddenly less competitive while European exporters are enjoying ballooning profits.
Considering that the national unemployment rate is down to 5.5% and inflation at well under their 2% target, it appears that no action to increase interest rates is called for by the Fed’s own standards. Americans are glad to have jobs but many highly trained and educated workers are still unemployed. The recovery has been slow but steady. Salary increases should follow the growth in sales and profitability. Acting too quickly to increase interest rates could reverse this trend. Waiting too long could require more extreme future measures.
Pimco expects global growth to accelerate +2.75% from around 2.5% in 2014. (Forecast from their 3/2/15 Cyclical Forum) They stated in their February 2015 Global Update:
“Our favorable outlook for the U.S. reflects healthy levels of consumer confidence, rising utilization rates and increasing plentiful financing, which should continue to underpin the recovery. With sustained growth likely to support a healthy pace of payroll gains, wage pressures are expected to gradually rise as the unemployment rate falls further. While the sharp decline in oil prices may temporarily push headline inflation into negative territory, we expect the Fed to take its policy signals from marginal wage gains and begin to raise policy interest rates gradually in the second half of 2015. As a result of the stronger growth outlook and likelihood of policy normalization, we expect the strength of the U.S. dollar versus other currencies to persist.”
Dr. Mark Skousen, economic professor at Chapman University, said that the Fed’s greatest fear is deflation, and raising interest rates could disrupt the entire recovery of our fragile economy. He opined that they might postpone raising rates until inflation and the GDP trend upward. (Interview on CNBC 4/2/2015)
For possible damage control, Federal Reserve Chair Janet Yellen later stated that a rate increase was unlikely for “at least the next couple” of meetings. The market responded favorably.
Marv Kaye, J.D., CFP® | Kaye Capital Management