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See-sawing on US rate rise

by Darrell Delamaide

See-sawing on US rate rise

Opinion has shifted again in the direction of a December US interest rate rise after an unexpectedly hawkish Federal Reserve statement in late October dropped reference to adverse international economic conditions as a possible hindrance to lift-off this year.

Earlier, in the run-up to the Federal Open Market Committee’s penultimate meeting of the year on 28 October, Fed-watchers had been sharply divided about whether the Fed would raise interest rates in 2015, after Fed sentiment seemed to be moving towards a decidedly dovish tilt. Now, the mood seems to have swung back again as anxiety over headwinds from the slowdown in China and other emerging markets has dissipated and scrutiny of US data again comes to the fore.

A fortnight earlier, Fed Governor Lael Brainard (voter), the former US Treasury official who joined the Fed board last year, dropped a minor policy bombshell on the quiet 12 October Columbus Day holiday, with a defiant challenge to Fed chair Janet Yellen’s ‘calendar-based’ statements forecasting lift-off this year.

The apparent see-sawing of dominant views on the FOMC has compounded market volatility recently, with some analysts criticising Yellen for failing to give adequately clear policy direction. As Stanley Fischer, the vice-chair (voter), admitted in Lima on 11 October at the annual IMF‒World Bank meetings, some emerging market central bankers have voiced impatience at Fed prevarication on the long-anticipated rate hike ‒ and have privately urged the US central bank to ‘just do it’.

While Fed policy-makers have consistently said the decision to begin monetary tightening would be data-driven, Brainard implicitly accused Yellen and Fischer of committing to a fixed schedule with their suggestions that the first rate rise for nine years would take place this year, even though, in her view, the data do not support it.

Brainard, in effect, questioned the appli-cability of the Phillips curve, saying the improvement in the labour market is not necessarily an indication inflation will rise. Given the Fed’s dual mandate of full employment and price stability, her view was that the central bank should hold off on tightening until inflation shows real signs of picking up. ‘In contrast to the considerable progress in the labour market, progress on the second leg of our dual mandate has been elusive,’ Brainard said in her speech at the National Association for Business Economics annual meeting.

‘To be clear, I do not view the improvement in the labour market as a sufficient statistic for judging the outlook for inflation.’ For Brainard, the data suggest ‘that the classic Phillips curve influence of resource utilisation on inflation is, at best, very weak at the moment.’ Wage growth has been slow, indicating considerable labour market slack is still pres

Double-barrelled mutiny
Dissension on the FOMC is not rare, but the dissenters are usually the regional Fed bank presidents, with the board governors almost always backing up the chair. If Brainard truly is signalling a dissent on a rate hike, it would put Yellen in a difficult position if she wants to stick to her forecast of a rise this year.

Furthermore, another board member, Daniel Tarullo (voter), who speaks more often on bank regulation than monetary policy, told a TV interviewer he did not ‘expect it would be appropriate’ to start raising rates this year. The double-barrelled statements from two of the five Fed governors prompted some headlines about ‘mutiny’ at the Fed.

In addition, New York Fed chief William Dudley, a permanent voting member and vice-chair of the FOMC, was ambivalent about the prospects for a 2015 rate increase. At a panel discussion at the Brookings Institution, he said a rate hike this year would still be on the cards if growth, employment and inflation were in line with earlier forecasts, but cautioned that new data suggest the economy is slowing.

In remarks quoted by the Italian newspaper CorrierEconomia, Dudley went even further. ‘The situation changed over the past few months,’ he said. ‘It’s true we thought we could raise interest rates by the end of 2015, but turbulence on financial markets, modest global growth, energy prices and macroprudential imbalances are slowing this process down.’

According to the newspaper, Dudley added it was ‘still too early to think about raising interest rates’. More ammunition for the doves came in a research paper from the San Francisco Fed, of which Yellen was president, suggesting that even at the zero-bound, interest rates are too high given a negative ‘natural rate of interest’, and are already contractionary rather than stimulative.

As recently as late September, Yellen repeated her forecast for a rate rise this year in a speech at the University of Massachusetts in Amherst, in the context of wanting to increase rates gradually and allowing for lags for policy to take effect. Combined with the forecast at that time that ‘various headwinds to economic growth’ will fade, these ‘are the key reasons that most of my colleagues and I anticipate that it will likely be appropriate to raise the target range for the federal funds rate sometime later this year’.

In addition, Fischer told IMF meeting parti-cipants in Lima that the economic projections prepared for the FOMC’s September meeting indicated that ‘most participants ‒ myself included ‒ anticipated that achieving these conditions would entail an initial increase in the federal funds rate later this year’. In the light of comments from Brainard, Tarullo and Dudley, a December rate rise is still not a foregone conclusion – but it looks a lot more likely than before the 28 October statement.

Darrell Delamaide is a writer and editor based in Washington.