Why the Fed Shouldn't Boost Rates Yet -- but May Anyway
New York (Aug 4) If this week's jobs report comes in as average or even weak, the Federal Reserve should probably postpone raising rates until later this year. But that doesn't mean it will.
Last week's economic news disappointed those who think the Fed will (or should) raise interest rates in September. Now it's up to the jobs report to make the case for that hike -- if a case can yet be made.
Fed Chair Janet Yellen has made clear that she expects to raise the fed funds rate sometime this year, in what will be the first rate hike since 2006. But the mediocre performance of the economy recently is raising the prospect that the already much-delayed tightening of monetary policy could be delayed again until the December meeting of the Federal Open Market Committee.
Economists expect Friday's jobs report to show 212,000 jobs were added in July, according to a survey by Econoday, down from last month's 223,000 or the 244,000 monthly average for the last year. That prediction follows last week's reports that the economy grew at a slower-than-expected 2.3% annual rate during the second quarter, and that wages rose only 2% over the last year. The reports didn't measure up to what Yellen described to Congress in mid-July, or what she told an audience in Cleveland on July 10, when she said a rate hike would come this year.
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The GDP growth rate is less than it was before the Fed raised rates in 2004 for the first time after the tech-bust recession. The ratio of unemployed people who have been out of work for six months or longer is still three percentage points higher than it was in June 2004. And the number of part-time workers who want full-time work is still 1.9 million higher than in 2004.
Core inflation, as measured by the index the Fed prefers, has been 1.2% the past year, well under its 2% target range, and counting the volatile food and energy segments, it's flat as a board. With oil plunging again, accelerating inflation isn't at hand.
If Yellen's mantra of "data dependency" means anything, the Fed should wait. But that doesn't make the decision easy.
"Janet Yellen has a very tough job, because this has been a very long recovery and at maybe the lowest levels [of growth] in U.S. history," said Andres Capital Management investment chief Bob Andres. "There's a reason she's afraid to raise rates and there's a reason they haven't."
The threshold for a rate hike should be 3% growth and some combination of 250,000 jobs and a return to the 2.3% year-over-year wage growth that the economy achieved in three of the first six months of the year. If Yellen & Co. settle for less, they are raising rates when GDP growth is at or below trend, job growth is decelerating, inflation is way below its target and there's a couple of million workers' worth of slack left in the jobs market, coupled with the factory capacity-utilization rate running seven percentage points below where it normally peaks in recoveries.
The Fed may not care, however. St. Louis Fed President James Bullard said Friday that the Fed is well-positioned to move in September.
The counter-argument Yellen has raised is that moving sooner gives the Fed leeway to raise rates more slowly, helping to convince markets that normalizing monetary policy is different than taking away the punchbowl just as the party gets going. And Janus bond manager Bill Gross insists that six years of near-zero rates have distorted financial markets. Bullard may be right when he says the market won't overreact to a quarter-point hike in the fed funds rate. But that doesn't address either of the Fed's two mandates, to control inflation and promote full employment.
Yes, bonds have done fine in previous Fed tightening cycles. Still, central banks raise rates for two reasons -- because they can, when growth is brisk and rate hikes won't hurt (the case Bullard is making, and which Yellen was hinting at before the most-recent data) or when they have to because inflation is looming. The GDP and personal-income reports didn't make the case under either test, especially with the Greece economy in shambles and the real state of China's markets obscured by a massive government intervention to prop up stocks.
Whether the jobs report and Wednesday's ADP report on private-sector hiring are any different looms as Wall Street's story of the week.