By Chris Berry (@cberry1)
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It would appear that Chair Yellen’s press conference yesterday set the stage for a Fed Funds rate increase in June or September of this year. We remain unconvinced.
It was interesting to note how financial markets reacted to the removal of a single word (patience) from the Fed’s most recent statement. The Dow, gold, and oil all roared higher and seemingly (for the moment anyway) forgot about the increasingly disappointing economic data in the US including housing starts, retail sales, and industrial production. Export growth has also slowed, and you can thank the strong US Dollar for that.
Couple this economic softness with the fact that just about any commodity you can think of from iron ore, to orange juice, to silver, to coffee, to copper is at or near a five year low and it becomes increasingly difficult to find any significant inflationary pressure and hence the imminent need for a (small) rate increase. The low oil price is actually a major culprit in keeping a lid on inflationary pressures.
Bond yields also collapsed after the press conference with the US Government 10 year yield plummeting to 1.92%. Chair Yellen repeatedly said during the press conference that the decision making at the Federal Reserve was “data dependent”. Does the data above cry out for a rate increase to moderate economic growth and make the cost of money more expensive? While job creation has been undeniably strong in recent months (an average of 290,000 over the last three months), it’s the sluggish wage growth and productivity that appear to be larger issues. We think it’s a stretch to assume that a single metric in job creation warrants an increase in rates.
It makes sense to raise rates eventually and “normalize” them as the zero lower bound where we now sit has distorted incentives for saving and investment. But has a preponderance of evidence really indicated that now is the time to consider a rate increase?
Watching to see whether or not QE helps the Euro Zone get back on its feet, whether China can continue above trend growth, and whether job gains in the US lead to solid wage gains are all clues to watch closely going forward. Thus far, these would warrant against any rate increase. With financial markets more interconnected than ever, one would hope that the Federal Reserve is scouring more than just US domestic data to consider when the time is right to alter its interest rate policy.
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