In 2015, the Fed decided to delay an interest rate hike several times; it was going to be the first hike in nearly ten years. The hike was initially planned to take place in June, but was then delayed. After that, September became the designated month. However, it took until December before the Fed finally used its main policy instrument.
Strong concerns about the US economy were the reason to delay a rate hike in June and September. The questions was whether the US economy would be strong enough to withstand a rate hike (by the way, I believe there is a different reason altogether, but more about that later on).
I find it rather ironic that the first hike since 2006 took place in the weakest quarter we’ve seen in years. It turns out that the US economy had only grown by 0.7% in the fourth quarter of 2015. For comparison’s sake: it was 2% the quarter before that.
A preliminary indicator provided by the Federal Reserve Bank of Chicago, which had been above 0 last year, dropped down to -0.24 in December. Zero means that US economic growth is around its secular trend. A score below zero means that the economy is growing slower than it does on average. If below -0.7, the economy is in a recession. The index consists of 85 indicators, of which 25 had pulled the index up, while 50 pulled it down.
I therefore wasn’t surprised when the Federal Open Market Committee, after their meeting last week, was more hesitant to provide positive remarks than they had a month earlier. In December, the fed said that consumption and investments were ‘strong’ in December, but this was downgraded to ‘moderate’ in January. According to the central bank, the export sector is ‘soft’ and inflation is too low. That means there was nothing left of the Fed’s euphoric December mood, when Jannet Yellen, the Fed chairwoman, noted that the economy was ‘surprisingly strong.’
Looking ahead, the Open Market Committee expects the economy to grow ‘moderately’ in the near to medium run, and inflation to remain very low. Furthermore, contrary to December, it no longer believes that the outlook for global economic growth and the exchange rate of the dollar are balanced. That means that, in December, the Fed did not expect those factors to stimulate, nor slow, economic growth. The fed decided to remove that passage from its January statement.
And that is telling! Apparently, the central bank had to pick between either saying that the US economy was more likely to slow down, or just drop the passage entirely. They ended up opting for the latter (and if the outlook for US economic growth were on the upside, the Fed would have been screaming it from the rooftops!).
The Fed gave another vague reference when they said they are ‘pledging to closely monitor developments in the global economy and financial markets.’ That is Fed jargon for ‘we’re looking at stock prices, we’re seeing them fall, and we are horrified by it;’ which is exactly what I meant when saying that I doubt whether economic conditions is a decisive factor for the Fed in deciding to hike or not to hike.
I strongly suspect that the Fed is mostly concerned with stock prices. In 2016, stock markets got off to a bad start. If markets continue to fall, it will lead to a more negative sentiment among US households. After all, they consider the stock market to be a sort of gauge for state of the US economy. When stock prices fall, they’ll feel less wealthy. If they expect they’ll become even less wealthy, they’ll start to believe the probability of being fired is higher. These are all factors that do not quite contribute to a more solid economic growth.
What impact will these factors have on the Fed’s policy later this year? I suspect that US economic growth will not only have been meager in the last quarter of 2015, but that it will continue that trend in Q1 of 2016. Recently, a large part of the US was struck by the largest snow storm in decades, and you can count on it that it will have some negative effects on growth.
If stock prices remain under pressure, which I expect to be fairly probable, while global economic growth is at lows not seen in years – just as the oil price is – then it would hardly be surprising if US economic growth is (significantly) lower than expected. And all of that while inflation remains far too low.
There is no doubt that this will have an impact on the Fed’s intended policy rate path for this year. Back in December, when the Fed announced their plans to hike the rate four times this year, I already thought it was too optimistic. I expect they’ll hike the rate once, or twice at most. Actually, I am counting on them hiking the rate only once.And just as recent economic developments in the US will have an impact on Fed policy, the latter will also have an impact on the ECB’s policy decisions. The Fed and ECB can be imagined as two cars driving on the same road. The ECB only has one goal: to make sure they keep driving behind the Fed. In other words: if the Fed fails to meet market expectations (to hike its rate), which has been priced into the euro/dollar exchange rate, then we’ll have to factor in the possibility that the ECB will loosen its monetary policy even more. That means that we’ll have to endure more misery (QE) in the Euro area this year, and for a longer period of time.