The balance of probability has now shifted to the Fed pushing back the decision yet again. In recent weeks the US stock market has sold off, corporate borrowing costs have increased and the dollar remains strong. All of this amounts to a tightening in financial conditions that will have a similar effect on the economy to raising interest rates.
If a rate rise did come in September it would now surprise financial markets, which is exactly what the Fed wants to avoid. But it doesn’t take much imagination to see how this could become a self-fulfilling prophecy: the Fed won’t hike because people don’t expect them to. That’s worrying. If financial markets start to think that the Fed is looking to them for their cue to raise rates then everything starts to look topsy turvy .
In fairness to the Fed, the economy is not exactly screaming out for a hike. Inflation is well below the target set by the central bank, wage growth has not picked up as it was expected to and there’s good reason to think the labour market can still improve further. However there is no escaping the fact that unemployment is very close to levels traditionally associated with full employment. More urgently, monetary policy is meant to be forward looking – you don’t wait for inflation to materialise before hiking, you try to head it off at the pass.
These arguments have some members of the Fed chomping at the bit to hike. Just not the influential ones. There is little difference between hiking in September and December in macroeconomic terms. But critically the timing of the first hike conveys how sensitive the Fed is to economic data and therefore possibly the path which rates might take over the long term. The Fed seems to think that going in September rather than December would imply to the market they are more hawkish than they really are.
One other reason the Fed may want to raise rates is to provide space to cut them again if another financial crisis develops. Wobbles in economies around the world in recent weeks and months only go to show how rickety the global recovery is after all. But it is not clear that hiking then cutting provides more stimulus than just keeping rates low. So all things considered there is little need to clip the wings of inflation which is not exactly taking flight. It seems the Fed may have decided to settle with the devil they know.
