US econ­omy ready­ing for De­cem­ber liftoff

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An over­whelm­ing num­ber of econ­o­mists polled are ex­pect­ing rates to in­crease within the next month; 92% of Key­ne­sian econ­o­mists sur­veyed by the Wall Street Jour­nal are of the opin­ion that the bench­mark Fed­eral Funds Rate will rise at the next FOMC meet­ing on De­cem­ber 15/16.

That the USD has been con­sis­tently strong is the rea­son why the rate in­crease was de­layed sev­eral times. The ob­tuse lan­guage used by the Fed and its pol­i­cy­mak­ers has been hard to read by econ­o­mists and an­a­lysts. How­ever, the slew of data about the rate hike has con­firmed expectations of rates be­ing raised within a month. The U.S. econ­omy has en­dured sev­eral shocks as a re­sult of China weak­ness and the con­comi­tant com­mod­ity price rout. Strangely though, only spe­cific sec­tors of the U.S. econ­omy have been feel­ing the ef­fects of global weak­ness. It is the very use of mon­e­tary pol­icy that is ca­pa­ble of achiev­ing the eco­nomic ob­jec­tives as set out by the Fed. This is done by way of mon­e­tary ex­pan­sion or mon­e­tary con­trac­tion, oftentimes in tan­dem with fis­cal pol­icy mea­sures such as vari­a­tions in gov­ern­ment ex­pen­di­ture or tax­a­tion.

Since the USD has been per­form­ing strongly of late, as is ev­i­dent by the US dol­lar in­dex, the Fed has en­acted mon­e­tary ex­pan­sion­ary mea­sures to coun­ter­act the neg­a­tive im­pact of a strong USD.

By flood­ing the mar­ket with more dol­lars, the de­mand for dol­lars de­clines and its ex­change rate falls ac­cord­ingly. In this par­tic­u­lar in­stance, a strong US dol­lar has not been coun­ter­acted by fur­ther mon­e­tary ex­pan­sion; rather it has been coun­ter­acted by in­ac­tion vis-a-vis in­ter­est-rate hikes. Some­times, the im­pact of not tak­ing ac­tion has just as much of an ef­fect on the over­all out­come as tak­ing de­ci­sive ac­tion.

Had the Fed de­cided to act in 2014, the USD would have strength­ened a lot quicker and this would likely have caused ir­repara­ble dam­age to the U.S. econ­omy and the global econ­omy too.

The most ob­vi­ous con­cerns for pol­i­cy­mak­ers in­clude USD strength and global eco­nomic weak­ness. Those are pre­cisely the rea­sons why a Septem­ber rate hike was re­jected. How­ever, by Oc­to­ber 28, the Fed state­ment ne­glected to men­tion any­thing about on­go­ing global eco­nomic events or re­lated devel­op­ments in the fi­nan­cial world.

The De­cem­ber 15/16 meet­ing is dif­fer­ent on many lev­els; the US econ­omy has now proven it­self to be re­silient and it is per­form­ing well. As such, the FOMC ap­pears to be sat­is­fied with the progress be­ing made on mul­ti­ple fronts. This in­cludes price sta­bil­ity, and max­i­mum em­ploy­ment. That the Fed has been tar­get­ing an in­fla­tion rate of 2% is well known, and many of the eco­nomic in­di­ca­tors re­flect strong progress be­ing made to­wards that tar­get.

There is no doubt that global growth is be­ing hurt by weak­ness in China. Ul­ti­mately, the syn­ergy be­tween dif­fer­ent com­po­nents of the global econ­omy will im­pact on U.S. eco­nomic per­for­mance. Re­al­is­ti­cally, the US has very lit­tle lee­way in terms of what it can do with the cur­rent level of in­ter­est rates. The ad­verse ef­fects of poor global per­for­mance will be dif­fi­cult to coun­ter­act with in­ter­est rates at 0.25%. As such, there has been a greater em­pha­sis on cau­tion­ary eco­nomic ac­tions.

New York Fed pres­i­dent Wil­liam Dud­ley has also been tightlipped about what he sees hap­pen­ing with the Fed de­ci­sion in De­cem­ber. He agrees that rate hikes are likely to take place, but he’s ex­pect­ing this to un­fold slowly. The fu­ture re­mains un­cer­tain and Dud­ley read­ily ad­mits to the dif­fi­culty in­volved in mon­e­tary pol­icy de­ci­sions. Had the in­fla­tion rate kept up with expectations, the de­ci­sions on the ground would have been that much eas­ier to make.

Even though his com­ments are dovish, Wil­liam Dud­ley has al­luded to now be­ing very close to the time for a rate hike. There is a slew of data be­tween now and De­cem­ber 16 to con­sider, but all signs are clearly point­ing in the di­rec­tion of a rate hike sooner, rather than later. An un­em­ploy­ment rate of 5.0% is a good sign, and strong Oc­to­ber non-farm pay­rolls growth cer­tainly gave plenty of im­pe­tus to the De­cem­ber liftoff.

The US dol­lar in­dex closed the trad­ing week on Fri­day at 98.80. This is an im­por­tant barom­e­ter of over­all USD strength as mea­sured against other cur­ren­cies in­clud­ing the SEK, the CHF, the GBP, the CAD, the JPY and the EUR.

US GDP has steadily been in­creas­ing from 2009 when it topped out at $14,418.7 bln to the 2014 fig­ure of $17,419 bln. In the quar­ter end­ing Septem­ber 30, GDP growth was mea­sured at 1.5%. This came in marginally un­der expectations of 1.6%. An­other GDP forecast will be an­nounced on Novem­ber 24 with Q3 as the ref­er­ence point. The con­sen­sus es­ti­mate is 1.5%. The all-im­por­tant core in­fla­tion rate in­creased to 1.9% in Septem­ber, from 1.8% in Au­gust. This is inch­ing ever closer to the 2% thresh­old set by the Fed.

The Fed has been toy­ing with the no­tion of rais­ing in­ter­est rates for quite some time. How­ever, the de­ci­sion to raise rates is an im­por­tant one since it has far-reach­ing im­pli­ca­tions on the do­mes­tic econ­omy and the global econ­omy. For starters, full em­ploy­ment will not be pos­si­ble and pro­duc­tion will start to de­cline. As it stands, hous­ing prices are in­flated, as are bond and eq­uity mar­kets. By keep­ing in­ter­est rates at the ab­nor­mally low lev­els they are at, the Fed can ac­com­mo­date eco­nomic growth by re­mov­ing bar­ri­ers to growth.

But it is im­pos­si­ble to keep in­ter­est rates at their cur­rent level for too long. If there is noth­ing to be gained by hold­ing money in a fixed in­ter­est-bear­ing ac­count, credit will be shunned. Savers will be com­pletely dis­cour­aged if they be­lieve that no yields will ac­crue from their ac­counts.

The Fed has been shift­ing the goal­posts ev­ery time it gets close to rais­ing in­ter­est rates and this tac­tic is widely used by cen­tral banks the world over. Third time’s a charm? That much will be re­vealed in the not too dis­tant fu­ture.

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