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Do-Nothingism, a Fine Idea for the Fed

By Edward O'Brien
June 1, 2016
in Analysts Coverage
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Janet Yellen is fond of saying that decisions by the Federal Reserve Board will be “data dependent.” In remarks on Friday at Harvard University she added that the Fed should raise rates “gradually and cautiously” as the economy improves.

If she’s true to her word, Ms. Yellen, the Fed’s chairwoman, will resist what many people think will be an interest rate increase when the Fed’s policy committee meets in mid-June. The underlying economic data — on jobs, prices and economic growth generally — simply do not support such an increase.

Widespread expectations of a rate increase arose in part from a misreading by investors of the minutes of a Fed meeting in April. What the minutes actually said was that “it likely would be appropriate” to raise rates in June — if economic growth picked up in the second quarter, if the labor market remained strong and if inflation rose from its depressed levels.

Those are very big ifs that, by all indications, are not being met.

Government data on economic growth in the second quarter will not be out before the Fed’s next meeting, but early signs are grim. In May, service-sector growth in the United States slowed markedly and manufacturing continued a steep decline, according to recent purchasing managers’ surveys by Markit, a data supplier. The surveys, which have been prescient, suggest that growth in the second quarter will be at a meager annual rate of 0.7 percent, on par with growth in the first quarter of 0.8 percent.

With economic news mixed, and seemingly positive news released one day followed by negative news the next, many industry experts remain fairly conservative about when and how much interest rate should rise. Still, rate-setting strategies are an inexact science, and consumer biases and expectations should be considered. Even when the Fed decides to raise the Federal Funds rate, it will likely take some time before real rates, which have remained at or below 1% for most of the past decade, to rise.

Overview by Ed O’Brien, Director, Banking Channels Advisory Service at Mercator Advisory Group

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Tags: Banking Channels

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