The Federal Reserve is no longer patient when it comes to normalising monetary policy, but neither is it showing itself to be particularly impatient about raising interest rates.
The Federal Open Market Committee (FOMC) downgraded its assessment of the US economy at its March meeting, noting that “economic growth has moderated somewhat”, and the Fed also did not seem as confident that soft inflation pressures were so transitory, citing the strong dollar as a further depressant on prices. The Fed’s interest-rate forecasts were also lowered significantly to imply a much more gradual pace of tightening once it actually begins, and more consistent with market estimates.
It also added that rates would rise when the Fed sees “further improvement in the labour market and is reasonably confident that inflation will move back to its 2 per cent objective”.
A rate increase was virtually ruled out at the FOMC meeting this month, but its options were left open for subsequent meetings allowing the Fed to achieve broadly what it wanted – more flexibility about the timing of rate increases, with a greater emphasis on being data-dependent. So no more calendars, thresholds, or coded expressions about being “patient” or keeping rates steady for a “considerable time”. Just watch the numbers.
Markets subsequently boiled down the Fed’s recent comments to imply that rates were either going up in June or September, with a majority taking the wording to suggest that the latter was more likely.
The distinction between expectations of a June increase and a September one is largely driven by relative optimism about growth.
Those looking for an early step up believe that US GDP growth will recover its momentum after a disappointing first quarter caused by bad weather, sufficient for the unemployment rate to fall further and for inflation to rise.
Those looking for a September increase clearly see the outlook as less rosy, with the recovery likely to be more drawn out, while the view that there will be no change in rates at all this year reflects an altogether darker perspective.
Consistent with this approach of simply watching the data, the release of the latest March jobs data will have sounded alarm bells in policy circles about the viability of raising interest rates in June.
And effectively it will have raised the bar in terms of what will be needed to be seen in the economic data in coming months if a rate increase in either September or June is to be at all likely.
After a small 126,000 increase in non-farm payrolls in March, combined with 69,000 of net downwards revisions to the two previous months, the average monthly increase in employment over the first quarter is now 197,000, as opposed to close to 300,000 in the three months before the March release and an average 269,000 over the previous 12 months. Furthermore, although average earnings rose by 0.3 per cent on the month, the average work week fell by 0.1 hours, taking it back to the level last seen in September of last year. That the unemployment rate stayed steady at 5.5 per cent can largely be put down to the participation rate falling by a tenth of a percentage point to 62.7 per cent.
This was the first truly weak labour market report for some time, breaking a run of 12 consecutive monthly gains above 200,000, something not seen since the 1990s.
And although it is always dangerous to overinterpret one single release, it is consistent with the drop-off in activity seen in other data over the quarter. This reinforces expectations that growth in the first quarter will decelerate further from its largely disappointing 2.2 per cent annualised pace in the fourth quarter of 2014.
This slowdown may well have been related to special factors, such as bad weather, a West Coast port strike and reduced oil drilling, but it still leaves the economy needing to make up even more ground this quarter and next if expectations of a September tightening are going to be grounded, let alone one in June.
The US economy probably can pull itself back up in the coming months, sufficient to see the unemployment rate to fall to about 5 per cent by September, in time for a rate increase then.
But it is now a tall order to expect this to happen a lot sooner, and the debate about September itself may now become a lot more fierce.
Tim Fox is the head of research and the chief economist at Emirates NBD