Fed holds off on interest rate hike. Why the decision was so tricky. (+video)(Read article summary)
Janet Yellen and the Federal Reserve are going to raise interest rates –not today, but maybe in October or December. But the current economy looks different than any before it, making the timing of a rate hike complicated.
After much anticipation, the Federal Reserve announced Thursday that it will keep interest rates near zero, citing a shaky global economy and slow growth on the domestic front.
"Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term,” the Fed said in a statement. The announcement concludes the Federal Open Market Committee's two-day meeting.
In comments following the release, Federal Reserve Chair Janet Yellen said that the FOMC needed more time to evaluate economic conditions, but reiterated that the Fed still will likely raise rates sometime this year and said that an October hike wasn't out of the question.
"I can't give you a recipe for exactly what we're looking to see," she said.
Analysts weren't surprised, though many thought today could have gone either way. “The decision will be seen by many as appropriate," MarkIt economist Chris Williamson wrote in e-mailed comments. "Although the domestic economy appears to be in sound health, current worries about slowing growth outside of the US, notably China, and recent financial market turmoil meant the Fed decided on balance that it’s not a good time for the first US rate hike in almost a decade. But the lack of action leaves lingering uncertainty about the outlook for US policymaking, which will no doubt fuel further volatility in the markets."
Despite the Fed’s strong suggestion in recent months that a rise in interest rates is looming, the exact timing of the hike is still a tossup. In a Reuters poll of 80 economists released Wednesday, 45 said they had expected the Fed to keep rates at or near zero percent during the September meeting. Thirty-five had expected a hike this afternoon. Bloomberg’s economist poll from last week was similarly split. Joshua Shapiro, an economist with MFR, Inc. wrote in an earlier e-mailed note that liftoff was slightly more likely in October, but “it is a close call, and we would not be shocked if they were to tighten today.”
That attitude was reflected in the financial markets Thursday morning. The Dow and S&P 500 went mostly unchanged as traders waited for the Fed’s decision. Minutes after the announcement Thursday afternoon, the Dow rose about 50 points.
Financial uncertainty overseas, particularly a slowdown in China, likely factored into the Fed's decision But there is also lingering uncertainty over the strength of the domestic economy as a whole. Despite undeniable progress in many areas, including the job market, weaknesses persist in other. It’s too early to tell whether such signals are indicative of a recovery that has a long way to go, or of lasting shifts that will characterize the economic picture in the coming years.
Below are a few of factors that have complicated the Fed's decision, starting with:
Job growth has been undeniably robust in 2015. The economy has added an average of 247,000 jobs per month over the past year, and the unemployment rate has fallen to 5.1 percent - a level many economists would have considered “full employment” in the past. But that robust pace slowed somewhat over the summer, and certain trouble spots in the employment picture haven’t gone away. The labor force participation rate, or the percentage of Americans working or actively looking for work, is near a four-decade low. The participation lag can be partially traced to a mass exodus of baby boomers leaving the workforce, but the youngest workers, 18 to 24-year-olds, are seeing a drop as well. Because of the slack, most analysts no longer view a low jobless rate as a reliable indicator of economic strength.
“Even with the significant gains in the past couple of years, it is only now, six years after the recession ended, that the labor market is approaching full strength,” Yellen said in prepared comments in May. “I say ‘approaching’ because in my judgment we are not there yet.”
Another reason to take those hearty jobs numbers with a grain of salt: Earnings for employees still haven’t taken off, stoking worries that over six years into the recovery, most Americans aren’t feeling it. According to the Labor Department’s latest Employment Cost Index (ECI), released in July, wages and salaries have grown 2.1 percent over the past 12 months. Earlier this month, a report from the the left-leaning National Employment Law Project (NELP) found that when taking inflation into account, wages have effectively fallen since 2009, and the country’s lowest-earning workers have taken the biggest hit.
“It’s a huge problem that wages aren’t growing faster, because it suggests the demand for labor is not really strong,” Diane Lim, an economist with the Committee for Economic Development (CED), told the Monitor in May.
Speaking of inflation, it’s still not where the Federal Reserve wants it. The core price index for personal consumption expenditures, or PCE, is the Fed’s preferred inflation measure, and it grew at a 1.24 percent rate in July – far below the Fed’s 2 percent goal. “Over time, a higher inflation rate would reduce the public's ability to make accurate longer-term economic and financial decisions,” a note on the Fed’s website reads. "On the other hand, a lower inflation rate would be associated with an elevated probability of falling into deflation.”
Consumer spending and GDP
On the bright side, domestic economic growth has picked up steam after a dismal start to 2015. GDP grew 3.7 percent in the second quarter of this year, and it’s on pace to grow 2.45 percent in Q3. But the last time the Fed raised rates, between 2004 and 2006, GDP growth was well over 4 percent.
Meanwhile, the most recent data on spending should give the Fed some confidence in the consumer economy going forward. Retail sales grew 0.2 percent in August, following a big gain in July.
“The consumer spending outlook is looking relatively positive for the remainder of the year due to real disposable income gains, modest consumer price inflation, lower energy prices, relatively solid employment gains, and a housing market that is gaining traction,” IHS Global Insight economist Chris Christopher wrote in an e-mailed note last week.