An influential Federal reserve member said on Saturday that due to low inflation and a strong dollar the U.S. central bank will likely remove accommodation at a gradual pace, suggesting that the Fed members are in no hurry to hike interest rates at the next Fed policy meeting in mid-September and prefer keeping interest rates with the federal funds at historic lows until inflation moves appreciably higher.
U.S. Federal Reserve Vice Chair Stanley Fischer gave a keynote speech on Saturday at the Federal Reserve Bank of Kansas City Economic Symposium in Jackson Hole, Wyoming and used the gathering of influential global central bankers to speak about the complicated economic web that impacts the Fed’s decision to raise interest rates which hasn’t occurred since 2006.
August has proven to be a volatile month for investors.
Global markets sold off earlier in the month after weaker than expected Chinese export and manufacturing data from July led to China’s central bank devaluing the yuan against the dollar on August 11th followed by a rate cut and lower reserve requirement for banks announced later on August 25th.
A slowdown in the world’s second largest economy is of particular concern to economists because China’s resiliency and unmatched growth during the global recession beginning in 2008 helped lift the economies of other regions across the globe.
Conversely, a cooling economy in China inevitably serves to drive down the cost of global crude oil and commodity prices which impacts inflation levels and can lead to deflationary pressure in other global economies.
Slower growth in China is undeniably one part of the narrative and catalysts explaining crude oil’s continual slide, reaching a 6 1/2 year low earlier last week before recovering on Thursday and Friday after short traders covered their short positions following some positive economic news, including higher than expected 2nd quarter U.S. GDP results on Thursday that rose to a brisk 3.7 percent.
“Commodity prices other than oil are also of relevance for inflation in the United States. Prices of metals and other industrial commodities, and agricultural products, are affected to a considerable extent by developments outside the United States, and the softness we’ve seen in these commodity prices, has in part reflected a slowing of demand from China and elsewhere. These prices likely have also been a factor in holding down inflation in the United States” said Fed Vice Chair Stanley Fischer in his speech yesterday.
On Friday the Bureau of Economic Analysis reported that U.S inflation, as measured by the PCE price index, rose just 0.1 percent in July compared with a 0.2 percent increase in June.
The Federal Reserve uses core PCE data as its primary inflation gauge for basing monetary policy.
Excluding food and energy, the July PCE index rose 1.2 percent from July a year ago, lower than 1.3 in June, and well below the Fed’s 2 percent inflation target.
The Dallas Fed’s trimmed mean measure of the PCE price index, another closely watched metric for Fed policy makers, is slightly higher at 1.6 percent but still low enough to justify accommodative policy measures such as keeping interest rates low for a longer period of time.
Four times a year, Fed members complete a short survey before their March, June, September, and December FOMC policy meetings.
In June, the central tendency of Fed members’ projections for core PCE inflation was 1.3 percent to 1.4 percent in 2015, 1.6 percent to 1.9 percent in 2016, and 1.9 percent to 2.0 percent in 2017.
Economists will be paying close attention to the latest projections for core PCE inflation during their next policy meeting from September 16-17th and watch for any major revisions that will have a future oriented impact on the Fed’s monetary policy with interest rates.
Another economic factor that has weighed down heavily on U.S. inflation has been a strong dollar in 2015 which has appreciated over 12 percent against major currencies since mid 2014 amid a confluence of factors such as growing expectations of U.S. monetary policy tightening in 2015 combined with strong U.S. economic data and monetary policy easing measures in Europe with the ECB and other world central bankers.
Fed Vice Chair Stanley Fischer said in his speech on Saturday that the dollar’s rise in 2015 with the exchange rate is primarily responsible for holding down inflation levels, even more so than falling crude oil prices, and pointed out that the appreciation has its largest effect on gross domestic product (GDP) growth in the second year after the shock.
“The rise in the dollar since last summer, of about 17 percent in nominal terms, with its associated declines in non-oil import prices, could plausibly be holding down core inflation quite noticeably this year” Fischer admitted in his speech after he explained that “It is plausible to think that the rise in the dollar over the past year would restrain growth of real GDP through 2016 and perhaps into 2017 as well.”
Later in his speech, Fischer explained that the Federal Reserve remains cautious to normalize Fed policy with interest rates at the federal funds which has been held near zero at 0.25 percent since December 2008 when former Fed Chair Ben Bernanke acted decisively to help stimulate U.S. growth in the economy.
“To do what monetary policy can do towards meeting our goals of maximum employment and price stability, and to ensure that these goals will continue to be met as we move ahead, we will most likely need to proceed cautiously in normalizing the stance of monetary policy’ Fischer explained.
“With inflation low, we can probably remove accommodation at a gradual pace. Yet, because monetary policy influences real activity with a substantial lag, we should not wait until inflation is back to 2 percent to begin tightening” Fischer added.
Last Wednesday U.S. stocks rallied after New York Fed President William Dudley threw cold water on the prospect of September rate hike, saying it looked “less compelling” than it did several weeks ago.
“At this moment, the decision to begin the normalization process at the September [FOMC] meeting seems less compelling to me than it did several weeks ago. But normalization could become more compelling by the time of the meeting as we get additional information” Dudley said.
Dudley later said that international developments have increased the down side risks but acknowledged that “incoming data suggests the US economy continues to grow at a moderate pace sufficient to cause a gradual tightening of the US labor market.”
On Friday Fed Vice Chairman Stanley Fischer was interviewed on CNBC and said that Fed members have still not decided whether to raise interest rates at the next September FOMC meeting and later explained that the U.S. could still be impacted by China’s slowdown and recent market volatility.
In yesterday’s speech, Vice Chair Fischer expanded on that theme and acknowledged that Fed policy changes will be based more on forward looking economic influences and the impact of foreign economies on U.S. growth.
“In making our monetary policy decisions, we are interested more in where the U.S. economy is heading than in knowing whence it has come. That is why we need to consider the overall state of the U.S. economy as well as the influence of foreign economies on the U.S. economy as we reach our judgment on whether and how to change monetary policy” Fed Vice Chair Stanley said during his speech.
This coming week economists and investors will be paying close attention on Friday to the non-farm employment report for August which is the last major data point before the Fed’s next policy meeting on September 16-17th.
Economists from briefing.com are forecasting non-farm payroll growth of 225,000 in August with the unemployment rate moving slightly higher to 5.4 percent from 5.3 percent in July.
Another employment report released on Wednesday, a private payroll report from ADP private payroll processor, will be released. Economists are forecasting 220,000 job growth in August which is above 185,000 in July.
- Full economic calendar will be reported during my next post on this site.
*Reported and written by: Johnathan Schweitzer