Blame it on the Brits? Fed Points at Brexit

June 16, 2016Economic Conditionsby EW News Desk Team

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Citing the economic risk of Britain leaving the European Union, Federal Reserve chief Janet Yellen kept interest rates low in an effort to help America's deteriorating economy.

While several negative economic indicators at home have moved analysts to predict a rate hike would not happen in June, the Fed chair cited the risks of a Brexit for both Americans and people around the world. When asked if the possibility of a Brexit influenced the Fed's decision to delay its plan on increasing Americans' borrowing costs, Yellen said it was a factor.

However, critics are arguing that a Brexit is economically tangential to America's economy, which is many times larger than the UK's. A primary concern has been weak job opportunities for Americans as companies refuse to expand hiring efforts.

The Federal Reserve's Labor Market Conditions Index has deteriorated in recent months, after May saw substantially weakening job growth and a fall in the labor force participation rate. Both trends negatively affect incomes and price growth.

Yellen dismissed the importance of the LMCI in the Fed's decision-making, calling the index "an experimental research project" with limited impact on the Fed itself. Nonetheless, Yellen acknowledged that America's labor market is not as strong as the Fed insisted it was just a few weeks ago.

"Information received since the Federal Open Market Committee met in April indicates that the pace of improvement in the labor market has slowed," the Fed said in a press release, adding that inflation remains low.

The Fed also hinted that its previously bullish position was wrong, and that it was backing off its previous hints of a tightening monetary policy. "The stance of monetary policy remains accommodative," the FOMC said, adding that "the current shortfall of inflation from 2 percent" and evolving economic conditions "will warrant only gradual increases in the federal funds rate."

The Federal Reserve also conceded that the funds rate, which is closely tied to many financial products, "is likely to remain, for some time, below levels that are expected to prevail in the longer run."

The recent backing off from an aggressively hawkish monetary policy has become common practice for the Fed. In 2011, the Federal Reserve announced its plans to begin raising interest rates, but fully reversed course and began the largest quantitative easing program in America's history within a year. Similarly, hints of plans to raise interest rates in 2014 and early 2015 remained unfulfilled as new, more disappointing economic data forced the Fed to reverse course.

Many analysts are now projecting just an interest rate hike to come in 2016, with some believing no rate hike will happen at all. The FOMC's unanimous vote to keep interest rates low, despite several FOMC members’ public pronouncements that it was time to raise rates in recent weeks, indicates the Fed's growing unease with current economic conditions and its previous plans for monetary policy.

The Federal Reserve has also downgraded its GDP estimates for 2016 from 2.2% to 2%, with inflation expectations expected at just 1.4%, far below the Fed's 2% target. Treasuries fell to near record lows, with the 10-year yielding just 1.576%.

A new auction of Treasuries also saw record demand from foreign buyers, pushing yields down further as institutional investors to flock to safe havens.

The Federal Reserve has raised its federal funds rate target once in the last decade: in December of last year. Within two months, United States stocks and corporate bonds saw declines of over 10%, but have since recovered.