WASHINGTON – Six weeks after raising interest rates for the first time in nearly a decade, Federal Reserve policymakers now face a more perilous global picture that could alter their plans for further raising rates this year.
Since the Fed increased rates Dec. 16 from record lows, stock markets have plunged, oil prices have skidded and China’s leaders have struggled to manage a slowdown in the world’s second-biggest economy.
Though some analysts say the Fed erred in raising rates last month, don’t expect the central bank to acknowledge so when it issues a statement after its latest policy meeting ends Wednesday afternoon.
But in their meeting, the Fed’s policymakers will surely grapple with how to respond to the altered landscape. And some analysts say the Fed might hint in its statement that the pace of three or four additional rate increases that many had expected this year may become more gradual — with perhaps only two rate hikes this year.
The most visible sign of the economic fear has been the sharp fall in the stock market. The Dow Jones industrial average shed more than 7 per cent of its value in the first three trading weeks of 2016.
China has unnerved investors because of an economic slowdown that Beijing seems incapable of steering properly. The country’s decelerating growth has shrunk global commodity prices and the emerging market countries that have supplied them to China. Last week, the price of oil reached a 12-year low of $28.15 a barrel before rebounding slightly this week.
The tumbling markets so far haven’t shaken consumer confidence. One measurement of confidence climbed for a second month, the Conference Board said Tuesday. Much of the optimism stems from solid job growth: U.S. employers added an average of 284,000 jobs a month in the final quarter of last year. And the unemployment rate remains a low 5 per cent.
The robust hiring has come despite weakness in American manufacturing. Export sales have slowed in part because a higher-valued dollar has made American goods more expensive overseas. The strong dollar has also made imports cheaper, which, along with falling energy prices, has kept inflation below the Fed’s target level for more than three years.
The economy’s growth, as measured by the gross domestic product, has lagged, with many analysts suggesting that it slowed to a sluggish annual rate below 1 per cent in the October-December quarter. Still, they foresee a rebound to a rate of around 2 per cent in the current January-March quarter, helped by strength in consumer spending.
Many point to the Fed’s December rate hike as a key factor in the stock market’s tumble. The move amounted to only a small rise in the Fed’s still-extremely low target rate for overnight bank lending. But it signalled that a seven-year period of near-zero rates was ending and that while borrowing costs wouldn’t be rising fast, they would be headed steadily up.
The Fed’s critics had warned for years that by keeping rates so low for so long, it was fueling dangerous bubbles in assets such as stocks. Some now see the falling stock prices as the correction that they had forecast would occur after the Fed started raising rates.
Others say the market’s swoon is not the product of the small increase in the Fed’s benchmark rate. They point instead to China’s economic troubles, the slide in oil prices and weakness in key areas of the global economy. Still, some economists suggest that if the Fed could have foreseen what has ensued in the weeks since it raised rates, it might have reconsidered.
A prolonged drop in the stock market can sometimes — but certainly not always — signal an impending recession. Most analysts note that the 6 1/2-year-old economic expansion has lasted longer than most. Yet they don’t see a recession as imminent.
Behravesh said he puts the possibility of a mild recession starting later this year at around 20 per cent. But he said his firm’s forecast is for the economy to rebound from a slow final three months of last year to growth of around 2.5 per cent this year.
And what should the Fed be doing?
The Fed may make some slight changes to its policy statement to express concern in particular about intensified global pressures. That could assure investors that the Fed will weigh such developments in deciding when to next raise rates.
Some economists foresee only two quarter-point rate hikes this year. Some other analysts think the Fed could stick with the four rate increases that officials had signalled could be coming this year, with the first hike possibly coming at the Fed’s next meeting in March.