Date
12 December 2017
A recent surge in the US dollar has hammered commodity prices. The greenback will only strengthen if major central banks continue to pump money into the financial system. Photo: Xinhua
A recent surge in the US dollar has hammered commodity prices. The greenback will only strengthen if major central banks continue to pump money into the financial system. Photo: Xinhua

Fed behind the curve in interest rate game

The Federal Reserve held interest rates steady on Wednesday as expected.

The focus now shifts to its future policy stance.

The Fed is behind the curve as shown by various data in recent months, which means there might be one or two rate hikes this year.

There is a small chance the Federal Open Market Committee, the Fed’s policy-setting body, will lift interest rates at its next meeting.

The numbers provide increasing evidence that it’s ready to do so.

The Fed will need to take into account a number of factors including unemployment, inflation and market conditions.

Monthly growth in new jobs in the non-farming sector has held steady at 220,000 in the past 12 months.

The unemployment rate is about 5 percent and the labor participation rate has been moving up.

Recent economic data has come in above market expectations, according to the Citi Economic Surprise Index (CESI).

It shows that the US job market and the overall economy have been growing despite adverse external conditions.

The consumer price index and personal consumption expenditure (PCE) both show that consumer prices have been rising in the past few months.

CESI shows that US inflation continues to exceed market expectations.

Meanwhile, financial markets continue to stabilize after a rocky start this year.

The St. Louis Fed Financial Stress Index and BofA Merrill Lynch Global Financial Stress Index are down from their peaks, suggesting more stable trading conditions.

Given these statistics, the Fed does not have a compelling reason to hold back a rate hike any longer.

The Taylor Rule, a measure of how a central bank should change the nominal interest rate in response to economic conditions, bolsters the argument for a 3.6 percent Fed Fund target rate given the unemployment rate and PCE.

That is more than 300 basis points above the current level.

Still, there is limited scope for a rate hike for a number of reasons.

US debt remains high even if household debt has fallen since the 2008 financial crisis.

Household debt is about 79.1 percent of gross domestic product, sharply down from 97.9 percent in the first quarter of 2008.

But corporates and the state have been ramping up their borrowing.

Non-financial sector leverage has stayed at 2.5 times, which means the US economy has a fairly high debt level.

A drastic move toward a rate hike could exert considerable deleveraging pressure across the board.

Also, a US rate hike could cause global market turmoil.

A recent surge in the US dollar has hammered commodity prices and triggered capital outflows from emerging markets.

The dollar will only strengthen if major central banks continue to pump money into the financial system.

This article appeared in the Hong Kong Economic Journal on March 17.

Translation by Julie Zhu

[Chinese version 中文版]

– Contact us at [email protected]

JZ/DY/RA

Hong Kong Economic Journal chief economist and strategist

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