Rising tensions within global financial markets were the dominant concerns among Fed officials according to minutes just released from their June policy meeting, leading to yet another delay in the Fed’s widely anticipated normalization of interest rate policy. Uncertainty surrounding the future of Greece and ongoing market weakness in China triggered a cautious tone among most members, although signs of continued strength in the domestic economy, especially the labor and housing markets provided enough signs encouragement for other members to favor a rate hike in the near future.
The tug of war between these two forces will be the dominant theme for Fed watchers going forward, and signs of either beginning to dominate in the weeks ahead should offer some more concrete insight into the timing of the Fed’s next move.
In the Fed’s own words:
“Many participants emphasized that, in order to determine that the criteria for beginning policy normalization had been met, they would need additional information indicating that economic growth was strengthening, that labor market conditions were continuing to improve, and that inflation was moving back toward the Committee’s objective.”
The Fed is essentially adopting a “wait and see” approach before pulling the trigger on a rate hike which might seem premature in hindsight.
The Good – Labor Market Continues to Pick Up
On a positive note, job creation and improved employment prospects according to official figures has buoyed the Fed’s expectations for wage growth to pick up for the rest of the year. Recent consumer confidence surveys echo the Fed’s optimism, with average consumers hopeful of real wage increases in the coming months. Increased wage growth would help boost the domestic economy going forward, and the Fed will likely keep monitoring the retail sales data and employment figures closely in the weeks and months ahead for signs of a solid platform of growth emerging.
The Bad and The Ugly – Greece Weighs on Fed Outlook
Dissecting the June minutes in more detail reveals the Fed’s growing concern about the disruptive influence of overseas market turmoil arriving on domestic shores. Greece clearly weighed on policy makers minds, with particular focus on the contagion “Grexit” would cause for European financial institutions, and the domino effect this could have on US banks.
The Fed didn’t mince any words in this regard.
“[M]any participants expressed concern that a failure of Greece and its official creditors to resolve their differences could result in disruptions in financial markets in the euro area, with possible spillover effects on the United States.”
An important point to note is that the June FOMC policy meeting took place well before the most recent turmoil in Greece really flared up. It’s almost certain that the Fed would be adopting even softer language surrounding Greece given recent events. The Chinese stock market has also imploded in recent weeks, and is likely to overshadow even Greece in the near future as the biggest threat to worldwide economic stability. In recent weeks China has employed a variety of increasingly desperate measures to help slow the stock market decline, but neighboring countries in the Asia Pacific region will be looking on anxiously for signs of contagion in the near future.
Inflation continues to remain below target
On the inflation front, the minutes identified stabilizing oil prices as a potential boost to inflationary pressures within the economy in the coming months. The Fed expects increased energy costs combined with a tightening labor market to help push inflation back towards its target of 2% by the end of year – current levels are well below target.
Summing up the inflation environment and economic picture in the Fed’s own words:
“The information reviewed for the June 16-17 meeting suggested that real gross domestic product (GDP) was increasing moderately in the second quarter after edging down in the first quarter. Labor market conditions improved somewhat further in recent months. Consumer price inflation continued to run below the FOMC’s longer-run objective of 2 percent and was restrained significantly by earlier declines in energy prices and decreases in prices of non-energy imports. Survey measures of longer‑run inflation expectations remained stable, while market-based measures of inflation compensation were still low.”
In summary, it is clear there is growing sense of frustration within the Fed with regards to its inability to start normalizing rates which have been set near zero percent since the onset of the 2008 crisis. With ongoing stress in world financial markets, the Fed knows a premature hike in rates would be enough to send many nations over the edge into a full blown recession. Upcoming domestic data will be key in the coming weeks, should there be a deterioration in the domestic economic picture, then all bets for any form of rate hike this year would certainly be off.
Andrew McCarthy is an expert in all things inflation. He has a Bachelors in Economics and has been working in the finance industry for over two decades.
