Can the Fed Help the U.S. Side-step a Worldwide Economic Malaise?

October 15, 2015Economic Conditionsby Deena Zaidi

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Even the U.S. may not be able to resist the gravitational pull of economic woe.

Markets and economists have long been obsessed with the Fed's first interest rate hike in nine years, but it seems the factors are not reciprocating positively to what the Fed is looking for. Reports on labor and emerging economies coupled with low inflation, strong dollar and falling commodity prices suggest that the US economy may not be as sound as expected.

Reaction to the jobs report

Lately, the economy has reflected some troubling numbers in its jobs report since the payrolls increased less than projected in September and wages remained stagnant. As the meltdown in emerging markets slowly ripple into the world's largest economy, many are left wondering whether the Fed should have increased the rates early this year.

Released on Friday, the weak job growth took many economists and stock markets by surprise. With the US jobs reports released, economists find it tough to look for a strong reason that will convince the Fed to raise the rates. Reacting to the jobs report on Friday, Carl Tannenbaum, chief economist at Northern Trust in Chicago, said that the chances of a move in December have "clearly diminished. There's nothing good in this morning's report."

What does the Fed look for when taking an interest rate decision?

In the Federal Reserve Act, the Congress clearly establishes full employment, stable prices and moderate long-term interest rates as its statutory objectives for monetary policies. But the current situation for the Fed hike seems a bit bewildering, since the objectives seem far from reaching their goal. The employment report remains weak, the inflation remains below the Fed's target levels and the interest rates have been kept close to zero since late 2008. Such weak findings have been further suffocated by additional factors that are more global and external in nature. China's slowdown and currency devaluation has led to many emerging economies engaging in currency wars and affecting their trade balances. With an existing strong dollar, the foreign debts are also seen to have increased exponentially for indebted nations. Falling commodity prices have resulted in huge losses for those who are major net exporters of commodities.

Has the Fed missed the window of opportunity?

Many economists feel that beginning of the year was the right time for the Fed to have increased the interest rates since the problem arising from China and other emerging markets did not exist. Prior to the Sept. 16-17 meet this year, Bill Gross, who manages a $1.5 billion bond fund for Janus Capital had mentioned that the timing and the eventual 'size' of the Fed interest rate hike may be 'too little, too late.'

In an interview with CNBC, Mohamed El Erian's thoughts seemed to align with Bill Gross's statements. "I would have hiked earlier and I would have gotten off zero earlier, but it's easier to say with hindsight," El-Erian told CNBC. "We know that there was a moment when domestic data was relatively strong and international data was okay. Now, the international data is really scary, and therefore the Fed has lost the opportunity when it had some alignment."

But the first two quarters of 2015 would have been a premature move for the Fed to take an interest decision since the economic picture of US started off on a weak economic activity and in second quarter, it was not convincing enough to take an affirmative action on the rate increase.

In the first quarter, the New York Times had reported that the unemployment had been falling steadily with experts believing it to fall to about 5 percent by the end of the year, from 5.4 percent then. But the US economy had contracted 0.7% with grim trade performance, strong dollar, spending cuts in energy sector, labor dispute and slowdown at the West Coast. 

The second quarter too had its own concerns that revolved around low inflation and lingering weaknesses in the labor markets. As observed by officials in the Fed's July 28-29 meeting, "the labor market had improved notably since early this year, but many saw scope for further improvement". The minutes had also mentioned "second-quarter economic growth was strong in China and in the United Kingdom." While the second quarter showed that the underlying growth of the US economy was stable, it was not so convincing to withstand an interest rate hike. Strong hints like inflation close to target level and strong employment data remained missing.

What Next...

So far in most of their meetings in 2015, the Fed has remained positive regarding employment outlook in hopes to push the inflation closer to the 2% target. However, low inflation and weak labor markets have been an issue in most of its meetings. In a speech on September 24th this year, Janet Yellen believed that with unemployment rate at 5.1% from 10% in 2009, the economy is not too far from achieving full employment. 

The maximum employment is dependent on a number of non-monetary factors that may not be directly quantifiable and hence there is no target employment rate that the Federal Open Market Committee (FOMC) sets. Through FOMC's September 2015 Summary of Economic Projections, past projections long-term unemployment rate normally range between 4.7% and 5.8%. As per the Labor Department, this figure remained steady at 5.1% (lowest in 7 years). The big disappointment comes from the number of new jobs generated. Economists polled by Reuters had expected to job growth of 203,000 but the US economy generated only 142,000 jobs in September. 

The jobs report reflects that the job data may have eventually caught up with the slowdown in China and other emerging markets. The Fed's interest rate decision will be highly determined by the employment performance and situation in emerging markets and unfortunately both look grim.

Is the US economy getting caught in the global turmoil? is republished with permission from the Financial Keyhole