Fed edging toward rate hike
Washington (July 28) The Federal Reserve is getting close to raising interest rates for the first time in nearly a decade, perhaps in September. When it meets this week, though, don't expect any timetable for a rate hike to be spelled out in a post-meeting statement. For now, the Fed wants to keep its options open.
Yet Chair Janet Yellen has left little doubt that the Fed is preparing to raise short-term rates by year's end from the record lows the central bank set at the depths of the 2008 financial crisis. With the U.S. economy and job market now steadily rising, the need for ultra-low rates to stimulate growth is fading.
"Our economy is in a much better state," Yellen told Congress this month. "We're close to where we want to be, and we now think the economy can not only tolerate but needs higher rates."
The economy still faces an array of threats, from subpar U.S. manufacturing and business investment to troubles in Europe and Asia, which have roiled financial markets. Inflation also remains below the Fed's target rate. And while the unemployment rate, at 5.3 percent, is nearly normal, other gauges of the job market remain less than healthy. Pay growth remains generally sluggish, for example, and many people are working part time because they can't find full-time jobs.
But Yellen has stressed that when the Fed begins to raise rates, it will do so only gradually. The idea is to avoid weakening an economy that's still benefiting from low borrowing rates resulting from the Fed's policies.
Yellen has suggested that raising rates in small increments, followed by pauses, would let the Fed assess the effects of slightly higher rates. Higher rates would also allow the Fed to respond later to any weakening of the economy by cutting rates again.
Though many economists foresee the first rate hike in September, when Yellen is scheduled to hold a news conference, others think the Fed might wait until December. On Wednesday, after its latest meeting ends, the Fed will issue only a statement.
"The recent volatility in the global economy and financial markets has given the Fed pause," said Sung Won Sohn, an economics professor at the Martin Smith School of Business at California State University, Channel Islands. "I think the probability of a rate hike in September has diminished because the Fed is going to need more time to evaluate how the U.S. economy is doing. December looks like a good possibility."
During Yellen's testimony to Congress this month, some Democrats urged her to consider delaying a rate hike given that inflation remains below the Fed's 2 percent target. The Fed has typically raised rates when it perceives a need to prevent inflation from getting out of control.
Part of the slowdown in inflation, though, reflects a plunge in oil prices over the past year, which will reverse itself once energy prices rebound.
The Fed is closer to achieving its other main goal: Maximizing employment. The unemployment rate is at a seven-year low, and over the past three months, U.S. hiring has averaged a robust 221,000 a month.
Economists who think the Fed will act in September point not only to low unemployment but also to signs of strength in such areas as housing and consumer spending.
"The economy has a lot of momentum, and if you don't start raising rates off zero, then it will be hard to curtail that momentum and inflation will become a problem down the road," said Mark Zandi, chief economist at Moody's Analytics.
There's also some concern that prolonged ultra-low rates may have begun to inflate dangerous bubbles in certain assets.
"The longer the Fed waits, the greater the bubbles will become in stock and bond prices and the more potential damage that could occur to the markets when the Fed finally acts," said economist David Jones, the author of several books on Fed policy.
Concern about igniting an overreaction in financial markets is a key reason economists think the Fed will show extreme caution in raising rates. Stocks and bonds suffered sharp declines in 2013 after the Fed initially mishandled its communications about when it would begin slowing a bond purchase program that was intended to keep long-term rates low.
"It has been so long since the Fed raised rates that the situation could be volatile," said Diane Swonk, chief economist at Mesirow Financial. "I believe the Fed is going to raise rates once, most likely in September, and then wait for some time before raising them again to judge market reaction."