At the upcoming December 15-16 FOMC meeting, Fed Chair Janet Yellen is likely to reiterate what she said at the Congressional testimony which is that the economy is expanding at a moderate pace and they made significant improvement in terms of reaching full-employment, said Michelle Meyer, deputy head of US economics at Bank of America Merrill Lynch.
Inflation is so low they think conditions warrant the beginning of the cycle. But really the conversation is how the path would look like. And that really still sounds pretty cautious. Yellen’s latest comments suggest that there’s really no promise in terms of how quickly the Fed’s going to hike rates.
Policymakers do want to see an environment where inflation is starting to pick up, and they want to have confidence that some of the downside risks from abroad have truly abated. So while they go in December, there will be a question about how quickly the cycle ends up looking, she noted.
Some of the recent economic data has not been that great; for instance the latest ISM manufacturing data was extremely weak while the services industry expanded at the weakest pace in six months. Additionally, consumer confidence has failed to bring the cheers back as well.
Asked how much long Yellen’s going to hold off and whether she risks a policy mistake hiking in December when the data has actually turned worse, Michelle said it’s true recent data hasn’t been stellar.
But the Fed is not looking at exceptional growth in order to start hiking. They are looking at the cumulative progress the economy has made and that’s why investors need to go back to the measures of output gap. Can it be argued that after several years of 2-½ percent GDP-growth, the US economy has closed the output gap? The unemployment rate has fallen to 5 percent, though it took a long time to get there. So, it allows the Fed to begin hiking and allows them to get off the zero bound.
But in order to continue to increase interest rates and get to a higher long term rate, they do need to see some momentum in the economy and they have to be confident that the cycle has still room to expand, she argued.
If the Fed does move in mid-December, it could trigger a rally in equities through the end of the year, said Samantha Azzarello, global market strategist at JP Morgan Fund. The move back to normalization is partly a confidence factor because realistically (speaking), the Federal Funds Rate probably should have been hiked six months ago. JP Morgan sees it as a positive, especially since there’s a lot of global easing going on that’s going to support risky assets, she noted.
While many market participants argue the Fed should have increased rates six months ago, there are many who believe they should not raise rates now because it could upset growth.
Asked to respond to the latter argument given to JP Morgan’s belief that markets will rise, Samantha said she doesn’t believe higher rates could derail recovery. Zero rates were an emergency measure, and the economy is not in need of emergency measures anymore even if the economy, to some extent, is puttering along at a 2 percent annual growth rate, she concluded.
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