Although Federal Reserve Chair Janet Yellen said she and her colleagues will probably start raising short-term interest rates “sometime later this year,” the timing of initial rate hikes remains uncertain—in no small part because of external concerns that ordinarily do not greatly impinge on U.S. monetary policy.
The Fed, as we all know, has a dual mandate to pursue price stability and maximum employment. And, as Yellen and other policymakers have often told us, it is “data dependent.”
Since March, the Fed’s rate-setting Federal Open Market Committee has said it will start raising the federal funds rate from near zero when it sees “further improvement in the labor market” and becomes “reasonably confident” inflation will rise to its 2% target “over the medium term.”
Yet, seldom if ever has the Fed been as focused on the global economy and related financial market conditions, exchange rates in particular, as now.
To be sure, the FOMC gave itself an out when, in changing its forward guidance in January, it said its assessments would include “readings on financial and international developments.” Increasingly, those readings have colored how most Fed officials appraise the domestic outlook, even as labor markets have continued to tighten in the context of above-trend growth.
Financial market developments take a backseat to worries about the slowdown in China, related declines in commodity prices and currencies and their repercussions for the United States, but the Fed sees them as interrelated. While professing indifference to market fluctuations, there is no question policymakers care about sustained, untoward changes in financial conditions to the extent they reflect a worsening global economic climate.
More than anything, Fed officials fret about continued dollar appreciation— not so much against the euro and yen as against the currencies of commodity producing nations. The dollar’s strength is seen having a persistent, double-edged effect; curbing net exports and in turn GDP growth and exerting downward pressure on import prices and in turn inflation.
The FOMC took the “out” it had given itself on Sept. 17, when officials had led many to believe it would at last raise rates. For instance, mainstream Atlanta Fed President Dennis Lockhart, a voter, had said it would take “significant deterioration” in the U.S. economy for the FOMC not to do so.
By all accounts, it was “a close call,” but despite largely encouraging domestic data, the FOMC once again delayed liftoff. And there was no doubt why. It said “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.”
Elaborating in her press conference, Yellen said “heightened concerns about growth in China and other emerging market economies have led to volatility in financial markets” and so “the outlook abroad appears to have become more uncertain.”
Yellen’s subsequent comment about a rate hike before year’s end was hardly a commitment. It is conditional on the economy staying on track to meet FOMC goals, and you can be sure that assessment could be swayed by what happens overseas.
Even before the cheerless September employment report and other data suggested manufacturing was hurting from weaker world growth and dollar strength, officials were disinclined to raise rates in late October. After the sharp drop in payroll gains and other signs of softness, there is an even greater desire to await more evidence.
Then too, though Fed officials have often said every FOMC meeting is “a live” one, there is a predisposition to act when both a Yellen press conference and a revised, quarterly Summary of Economic Projections are scheduled. Other things being equal, that makes a December liftoff more likely and officials insist year-end money market pressures would not present a major obstacle.
However, if Yellen and Co. don’t see the kind of domestic and international picture they like, liftoff could be delayed until next year, when the first Yellen press conference is scheduled for March 16.