Economic Commentaries


The Federal Reserve’s open market committee meets this week amidst high expectations that it will affirm a move toward normalizing the interest rate structure at some point this summer. There are three reasons. First. The Fed is anxious to move off the zero bound because it believes there is no longer an economic emergency. Second, job growth is strong and the jobless rate is approximating what the Fed believes is the noninflationary fully employed rate. Third, the Fed seems convinced that inflation will move toward its 2% target relatively soon.

We are fully aware of the Fed’s anxiety. But we are less convinced of the timing than most financial market participants seem to be. Economic growth in the winter quarter is running between 1% and 2% annually with inflation at the same rate but with a minus sign in front of it. If so, this would be a second consecutive quarter wherein nominal GDP approximates zero.

To be sure, adverse weather and the L.A. port strike were disruptive. These should be less of a drag going forward and indeed a measurable rebound in activity should soon be evident. However, the downturn in the energy patch has not yet been fully reflected in economic data reports. This should blunt any perceived rebound and indeed many are beginning to be dissuaded of the notion that the energy downturn will be short lived.

As for the noninflationary jobless rate, we have in the past cited several reasons for believing the rate is considerably lower than the 5% to 5.5% presumption of the Federal Reserve. This remains to be seen but as yet the key indicator of wage growth is failing to signal labor market tightness. Aggregate earnings growth remains mired around 2% annually. And recent boosts in the minimum wage and wage hikes among selected large retailers will have little if any measurable effect.

Finally, were the Fed to begin normalizing while every other Central Bank is aggressively accommodating, the dollar exchange rate would likely gain even further strength. This would put additional downward pressure on commodity prices at a time when supply-demand fundamentals are already exerting downward pressure. The result would an intensifying deflationary impulse.

Thus, while the Fed may be anticipating that inflation will move toward its target, its presumed actions may well cause inflation to move further from its target. Officials are emphasizing that any rate rise would not necessarily be the beginning of a continuous process. It would be ironic if one small rate rise were eventually to be followed by one small rate decline. In short, we will stick by our lower for longer mantra.

Posted in: General