Wednesday, March 16, 2016

Fed keeping rates low an interesting choice

With the economy hitting a soft patch earlier this year, but with job growth and oil prices on the way back up, today’s meeting of the Federal Reserve Board of Governors had a little more attention than normal, as traders, savers and others wanted to see if the Fed would stay on track to raise interest rates back to a more normal level by the end of this year.

Turns out that wasn’t the case, as the Fed made a relatively surprising announcement that rates would stay low, not just in the short term, but for the near future.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen. However, global economic and financial developments continue to pose risks. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further. The Committee continues to monitor inflation developments closely.

Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent. The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.
The Wall Streeters were happy to hear those words coming from the Fed, and the DOW Jones jumped more than 150 points in 45 minutes, and went from being down 26 points before the Fed announcement to being up more than 74 points when the market closed 2 hours later.

Here’s how The Street summed up the Fed meeting and the associated economic data.
The central bank now expects two rate hikes this year, down from December's forecasts for four hikes over 2016. The Fed also cut its forecasts for next year's hikes by 50 basis points.

"Tightening should continue (slowly) because employment continues to improve, fulfilling part of their mandate, while the resulting tightness in some labor markets is leading to wage inflation pressures, which affects the other part of their mandate," said Jason Pride, director of investment strategy at Glenmede. (I don’t get this part at all, because tightening should be considered if employment growth and wage inflation is happening. Sounds like word salad).

The central bank upgraded its assessment of the U.S. economy, particularly inflation. Members expects full-year GDP growth of 2.2%, down from 2.4% previously forecast. However, members also upgraded their concern over global economic developments.
I find that 2016 growth estimate intriguing, because even while the estimates for full-year GDP growth was reduced, it also is still higher than the Atlanta Fed’s estimate of 1.9% growth for the 1st Quarter of this year, which means the Fed Board anticipates higher growth the rest of the year.

What could prove to be a complication in higher real GDP growth is the increasing inflation that the Fed Board of Governors claims will be a short-term blip and eventually evened out. I’m not quite sure about that, as the U.S. Consumer Price Index seems to be on the way up, . The overall year-over-year increase in the CPI from February 2015- February 2016 was only 1.0%, but that’s largely due to a drop of more than 20% in the price of gas in that time, and now those savings are likely to reverse (gas now over $2 in some parts of Madison vs the $1.61 I paid 6 weeks ago). The BLS notes that core inflation (less food and energy) went up 0.3% for the second month in a row in February, and the underlying amount of 12-month inflation is above the Fed’s benchmark, with0 housing especially becoming pricey.
The index for all items less food and energy increased 2.3 percent over the past 12 months, a figure that has been slowly rising since it was 1.7 percent for the 12 months ending May 2015. The index for shelter has risen 3.3 percent over the last year, its largest 12-month increase since the period ending September 2007, and the medical care index has increased 3.5 percent, its largest rise since October 2012.
But maybe the Fed is counting on wages to stagnate yet again in 2016 to keep a lid on the amount of inflation. Any fears about growing wage inflation for the short-term should be put aside, as actual wages went down in February, and only the drop in gasoline kept workers from falling behind.
Real average hourly earnings for all employees were unchanged from January to February, seasonally adjusted, the U.S. Bureau of Labor Statistics reported today. This result stems from a 0.1-percent decrease in average hourly earnings being offset by a 0.2-percent decrease in the Consumer Price Index for All Urban Consumers (CPI-U).

Real average weekly earnings decreased 0.5 percent over the month due to no change in real average hourly earnings combined with a 0.6-percent decrease in the average workweek.

Real average hourly earnings increased 1.2 percent, seasonally adjusted, from February 2015 to February 2016. This increase in real average hourly earnings, combined with a 0.6-percent decrease in the average workweek, resulted in a 0.6-percent increase in real average weekly earnings over this

WOO HOO! A 0.6% increase after inflation! Don’t spend it all in one place, kids!

So we will see if the Fed’s gamble that prices, wages and GDP growth will remain at “slow but steady” levels will allow it to take its time to raise rates, letting the Wall Street cocaine party of bubble-making cheerfulness continue. But I’m seeing a few warning signs out there that tell me things could well turn the other way as summer driving season heats up - a situation that would lead to prices going up without wages going up with it, and the Fed being stuck no matter which way they turn.

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