Can Janet Yellen keep her promise to raise interest rates in 2015?

A growing chorus of voices is urging the Fed to wait just a little longer, but the Fed chair looks likely to follow her gut instinct

 
International Monetary Fund managing director Christine Lagarde, left and Federal Reserve Chair Janet Yellen
International Monetary Fund managing director Christine Lagarde, left and Federal Reserve Chair Janet Yellen at a 2014 interview. Yellen earlier committed to raising interest rates in 2015, but Lagarde recently spoke in favour of extending the Fed’s timeline. (Jim Watson/AFP/Getty)

Bank of Nova Scotia chief executive Brian Porter thinks it’s time for the U.S. Federal Reserve to raise interest rates. The Fed may be on the verge of agreeing with him. The U.S. central bank’s policy committee on Wednesday ignored a mini-streak of lacklustre economic data and issued a statement that sets the stage for the first increase in official interest rates since 2006.

Many thought that increase would come in September, but Fed officials got spooked by China. “Recent global economic and financial developments may restrain economic activity and are likely to put further downward pressure on inflation in the near term,” the Federal Open Market Committee said then. That worry was scrubbed from the October statement, suggesting Fed chair Janet Yellen and her No. 2, Stanley Fischer, were reassured by what they heard at the annual meetings of the IMF and World Bank in Lima, Peru earlier this month. The new statement observed that, “on balance,” employment indicators “show that the underutilization of labour resources has diminished since the early this year.” That ugly phrase is important. By itself, the unemployment rate has been an argument for higher interest rates for months. Yellen has argued against tighter policy because other labour-market indicators were less positive. Measures such as the number of part-time workers who want full-time jobs are catching up to the jobless rate, which was 5.1% in September, the lowest since the spring of 2008. “The Fed wants to go in December,” said Tom Porcelli, chief U.S. economist at RBC Capital.

It has become fashionable to pressure Yellen to resist her inclination to lift borrowing costs this year. Both Christine Lagarde, the managing director of the International Monetary Fund, and Kaushik Basu, chief economist at the World Bank, said this fall that America’s benchmark interest rate should remain at zero until 2016. The crux of the case against tighter monetary policy is that inflation remains weak, so why bother? Might as well keep the pedal down until the prices become an obvious problem.

That argument could yet win out. According to RBC, securities tied to the Fed’s policy rate now suggest a 50% chance of an increase when the Fed’s policy committee makes its next decision on Dec. 16. When policy makers sequestered to review their options this week, the odds were only about 30%. There is a shift in perception, but still no consensus.

Economic data over the next few weeks will be decisive. On Thursday, the Commerce Department released its initial estimate of third-quarter gross domestic product. GDP expanded at an annual rate of 1.5%, compared with 3.9% in the previous quarter. The slowdown was in line with Wall Street estimates and isn’t necessarily a disappointment, as second-quarter growth was faster than any mature economy could maintain. Household spending rose at an annual rate of 3.2%, a decent gain. Exports slowed, rising only 1.9% after posting an increase of 5.1% in the second quarter. A big drop in inventories was responsible for much of the overall decline. That suggests room for growth in the fourth quarter and companies replenish stockpiles.

The Fed’s shift China was significant. It mirrors the Bank of Canada, which put a positive twist on its assessment of the world’s second-biggest economy earlier this month. Canada’s central bank acknowledged that worries over slowing economic growth in China were weighing on commodity prices. But in its quarterly report on the economy, policy makers went out of their way to emphasize the difference between slower growth and no growth. For example, Chinese imports of copper ore were some 760 million tonnes greater in the first nine months of 2015 than the same period a year earlier, the Bank of Canada said. The message: don’t over-interpret volatile commodity markets; China still is buying more stuff.

Few believe a quarter-point increase by the Fed will make a material difference to the real economy. In Lima, the message Yellen and Fischer got from most of their counterparts was that the Fed’s indecision was driving them crazy. The other factor to consider is credibility. To backtrack on raising interest rates in 2015—after stating explicitly that she intended to do so—would be a blow to Yellen’s authority. There’s no reason to think the Fed’s decision will be guided by personal pride. If the data through mid-December deteriorate, then the central bank will wait. But if little changes over the next six weeks and the decision comes down to a coin flip? Yellen will stick with what her gut has been telling her for months. Wouldn’t anyone?

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