The U.S. Fed’s interest rate hike is a message: inflation is back

With U.S. unemployment fairly low and prices set to rise, the Fed is clearly preparing to raise interest rates more. But prepare for a slow climb

 
Federal Reserve chair Janet Yellen

U.S. Federal Reserve chair Janet Yellen. (Alex Wong/Getty)

It is time to resume watching inflation.

For years, if you wanted to guess the path of interest rates, you watched hiring indicators. Unsatisfied with the unemployment rate, the U.S. Federal Reserve added numerous other labour-related gauges to its dashboard, including participation numbers and the pace at which Americans were quitting their jobs. Prices were lifeless, so the Fed had space to concentrate exclusively on the other part of its mandate: jobs.

The Fed is close to declaring “Mission Accomplished” on that front. The central bank’s policy committee voted unanimously on Dec. 14 to raise its benchmark interest rate a quarter point to 0.5%. “Job gains have been solid in recent months and the unemployment rate has declined,” the Fed said in its policy statement. It was the first increase in a year and only the second since 2006, but there is reason to think the Fed wants to pick up the pace. In September, when the Fed’s policy makers last submitted their economic outlooks, the median estimate implied two quarter-point increases in 2017. The assumption now is for three increases next year; a “very tiny” shift, said Fed chair Janet Yellen. Still, a shift all the same. The priority now is staying ahead of inflation.

It is important not to exaggerate the Fed’s pivot. The central bank emphasized that its interest-rate setting remains accommodative, and that “some further strengthening” of the labour market would be desirable. Yellen said at a press conference that she harbours no concern that inflation is an imminent threat. The Fed sees annual price increases of 1.8% next year, slower than its target of 2%.

Yet stock markets dropped. That’s because Yellen demonstrated more concern about prices than at any point during her tenure. Earlier this year, she mused about letting an economy run hot to create opportunities for marginalized workers. On December 14, she said that if anyone thought her comments reflected a change in Fed policy, then they were mistaken. Yellen was also asked about previous calls from the Fed for greater spending by government. President-elect Donald Trump wants to cut taxes and spend hundreds of millions of dollars on infrastructure. Yellen’s response: too late. “We called for fiscal stimulus when the unemployment rate was substantially higher than it is now,” she said. “Fiscal policy is not obviously needed to provide stimulus to get back to full employment.”

There will be a temptation to use those remarks to suggest that the Fed and the Trump administration are poised to clash. The president-elect promised annual economic growth of 4% during the campaign; all things equal, higher interest rates would make that harder to achieve. Trump also criticized low interest rates during the campaign, so who knows? Yellen said some of her colleagues incorporated fiscal stimulus in their forecasts, while others didn’t. “We are operating under a cloud of uncertainty,” she said. The Fed will continue to set policy based on data and adjust when the Trump and the Congress pass legislation. That could take months. Higher rates are coming, but not overnight. Executives, investors and the next commander in chief should have plenty of time to adjust.


MORE ABOUT INTEREST RATES:

Get our daily briefing on innovation, leadership, technology & the economy.
Weekdays at 6 AM ET. Learn More »

Comments are closed.