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Fed seen deferring rate hike despite unemployment fall

Saturday, September 5, 2015 - 11:11
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The Federal Reserve is expected to put off a long-planned interest rate increase this month despite another fall in the US jobless rate, placing concerns about China ahead of US data.

[WASHINGTON] The Federal Reserve is expected to put off a long-planned interest rate increase this month despite another fall in the US jobless rate, placing concerns about China ahead of US data.

Analysts said on Friday that the mixed August jobs report - job creation slowed to 173,000 but unemployment fell to 5.1 per cent - backed the Fed launching on a long-awaited series of rate hikes to "normalize" monetary policy after years in crisis mode. But continued worries about Beijing's ability to counter the downturn in its huge economy, and the stress that has brought in global financial markets, will likely give Fed Chair Janet Yellen and her team pause before pushing ahead.

"Their main concern has not been the current state of the domestic economy, which we know has been strong, but fears about possible spill-overs from China and the stock market volatility on future activity," said Harm Bandholz of UniCredit.

The policy-setting Federal Open Market Committee has appeared anxious to get past an initial increase in the benchmark federal funds rate, which has sat at zero per cent since 2008 to reboot the economy after the Great Recession.

Critics say the ultra-low rate is no longer helping growth but is feeding excessive speculation and overly high prices in asset markets, and threatens to spark a burst of inflation.

But defenders say low rates remain justified by the slow levels of investment and consumer spending, and the lack of any real signs of inflation. Even so, analysts said those arguments have been pushed to the side by the economic turmoil especially since China's August 11 yuan devaluation.

The International Monetary Fund (IMF) warned this week that the fallout from China's troubles on other economies could be larger than expected. Those considerations are likely to gain greater weight than domestic indicators when the FOMC meets next on monetary policy, on September 16-17.

On Friday, the worries continued: the leading markets in Japan and Europe fell more than 2.2 per cent, and on Wall Street the S&P 500 dropped 1.5 per cent.

"The question remains how much weight the Fed will place on positive labor market data and whether or not this will outweigh their more skeptical views on inflation and global market instability," said analyst Kim Chase of BBVA in a client note.

The case for a rate rise, to most analysts, increased with the August employment report. The 5.1 per cent jobless rate, the lowest level since April 2008, is well within the Fed's parameters for tightening policy.

But other barometers are not. The main one is inflation, which has held below the Fed's 2.0 per cent comfort zone, though mainly because of the plunge in prices of oil and other commodities.

Wage gains remain slow, at 2.2 per cent year-on-year. In addition, there is no sign that the jobs market is drawing back in dropouts or delivering more well-paid jobs to people. Yellen has made clear that those are crucial to her.

Dean Baker of the Center for Economic and Policy Research said the overall jobs report was "not especially positive."

"There is no evidence that wage growth is accelerating and there is a real risk that employment growth is slowing."

On the other hand, Fed Vice Chair Stanley Fischer, a Yellen policy ally, made clear last week that low inflation is not seen as a problem now.

"We should not wait until inflation is back to two per cent to begin tightening," he said last week.

Jeffrey Lacker, head of the Fed's Richmond branch and one of the minority "inflation hawks" on the FOMC, made a strong argument on Thursday for raising rates now. He said the jobless rate has long gone below FOMC targets and that inflation has already topped the target over the past six months.

"Recent financial market volatility is unlikely to affect economic fundamentals in the United States and thus has limited implications for monetary policy," he argued. "Waiting too long to begin raising rates could require a more dramatic increase in rates to restrain inflation pressures once they have become apparent in the data."

Technically, there is no reason why the Fed could hold to a wait-and-see stance. After the September meeting, it meets again in October and December, when the picture from China could become clearer. But as Yellen has stressed, the Fed wants to normalize rates only very slowly, and so the later they start, the steeper the increase could be if the US economy accelerates.

AFP

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