It has been 81 months, and counting. The US Federal Reserve has missed another opportunity to raise interest rates. Instead, Janet Yellen and her fellow committee members cited global economic and financial uncertainty, sidelining Fed policy for at least another month. The problem with the Federal Reserve’s decision Thursday, and in turn their decision making process is that it paves way for greater uncertainty. Furthermore, investors are now right to question the outlook for the US economy, the ongoing impact of the slowdown in emerging markets, and what the path forward is for the US Fed as Yellen made clear a rate hike could come as soon as October, or perhaps not until 2016. It will now be difficult for the Fed to avoid something they’ve worked so hard not to do, and that’s not surprise the markets.
Without a doubt it was the recent financial market volatility, which emanated in Chinese stocks but spread all the way to US exchanges that kept the Fed on hold. Very succinctly, the FOMC statement read that they continue “to see the risks to the outlook for economic activity and the labor market as nearly balanced but [are] monitoring developments abroad.” What is meant by that statement is that with an employment rate approaching 5 per cent and GDP growth expected between 2.5 and 3 per cent, uncertainty from emerging markets is what has kept them on hold. This in turn revised their outlook lower for interest rates in the US in 2016.
This change from their most recent June meeting was their future forecasts for the federal funds rate and the path of liftoff became a lot more gradual. The projected timeline for higher interest rates will be a lot longer than previously anticipated. This is in part to do with weak domestic inflation, but also allows the Fed breathing room between rate hikes to ensure the economy does not see tightening occur too quickly. As many have cited, recent financial market activity has had a tightening effects on the economy already. Whether it’s higher interest rates, hits to market value of equity portfolios, or the rising dollar depreciating foreign revenues, American’s are being hit with the same deflationary pressures they put on their trading partners when they embarked on quantitative easing. This deflationary dilemma could remain a substantial issue for the Fed as it keeps a lid on US inflation.
Finally, it cannot be forgotten that the idea of a hike in interest rates is based on a strengthening outlook for the economy. September 17 of 2015 was the highly anticipated date for the Fed to raise interest rates because of labour market improvement, a recovering housing market, and a recovering economy. It seems we’ve hit a snag. There is an argument with the US economy at full employment as wage growth in the labour market could jump start inflation. As there is a shortage of workers to hire and productivity increases, firms compete for labour and pay skilled workers more to retain talent. The problem with this theory is the participation rate is at the lowest level since the 1970’s and accounting for underemployment (estimated at approximately 10 million American’s) means the employment rate may be more likely to go sideways than lower. The US labour market still has further to recover.
Whether or not the Federal Reserve was right to not raise interest rates is no longer the issue from Thursday’s policy announcement. The issue is that the Fed, after years of increased transparency and attempting to deliver a clear message to the market, just became a little less transparent. Janet Yellen and her team will be hard pressed to minimize the uncertainty they created from today’s inaction. The reason is not because they didn’t raise interest rates, but when the investors have been led to expect them to raise rates, the question is why not.