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01-08-2015, 09:14 PM
Fed has excellent excuse for a rate rise delay
671 words
31 Jul 2015
The Australian Financial Review
AFNR
English
The US central bank has only given itself a grade of 50 per cent in its latest scorecard, believing that although it has succeeded in reviving the flailing US jobs market, it has failed to do the same with inflation.
But while most of us would start looking for another job after such a mediocre performance review, the US Federal Reserve need have no such fears.
Indeed, investors cheered the statement put out after the Fed's latest policy meeting, believing that it pushes the date for any interest rate rise even further into the future.
By highlighting the patchy progress it is making in achieving its "dual mandate", the US central bank has given itself an excellent excuse if it decides to postpone the difficult decision of whether to raise interest rates until 2016.
Janet Yellen, the Fed's chairwoman, has previously warned investors to expect rate rises this year, although she has always added the caveat that the Fed would look to the economic data before moving its key interest rate, which it has kept close to zero since December 2008.
And at this stage, the data is giving decidedly mixed signals. On the unemployment front, the Fed has reason to boast, with the US jobless rate almost halving from 10 per cent in 2009 to 5.3 per cent in June.
In its latest statement, Fed officials congratulated themselves on the "solid job gains and declining unemployment". They also pointed to the pick-up in hiring and the reduction in the amount of slack in the labour market, suggesting that they believe the economy is getting closer to their full employment goal.
But Fed officials had no choice but to concede that they have failed in their attempts to fan price pressures. The Fed's favourite inflation measure remains stuck below 2 per cent - where it has been for three straight years.
Even worse, there are more deflationary pressures brewing. The sharp slowdown in China has caused commodity prices to tumble. At the same time, the stronger US dollar has sliced the cost of imports, putting pressure on US producers to cut prices to maintain market share.
After its meeting in June, the Fed hopefully noted that energy prices had stabilised, which suggested that it was hopeful that the downward price pressures from lower oil prices were fading. But the sharp drop in the oil price in the past few weeks meant there was no mention of stable energy prices in Wednesday's statement. Instead, the Fed warned that it would continue "to monitor inflation developments closely", a sign of its concern that price pressures continue to languish. Rates would only rise when the Fed is "reasonably confident" that inflation will move back to its 2 per cent target.
But the Fed's critics believe that the US central bank - and particularly its policy of keeping interest rates close to zero - is itself to blame for the dearth of inflation.
They argue that artificially low interest rates encourage investors to borrow money and buy existing assets, such as real estate, that already generate dependable income streams, rather than take the risk of investing in new plant and equipment that create jobs.
What's more, they encourage the misallocation of resources. It's unlikely that the US oil and gas exploration boom, which saw US investment banks making around $1 trillion in loans to energy companies (most of which they then sold to investors) would have been possible without such extremely low interest rates.
But such massive misallocation of capital causes the economy's growth rate to tumble, even though debt levels continue to rise.
Eventually, they warn, the economy reaches a point- even with interest rates close to zero - where the return on capital is less than the cost of capital. As nervous investors start to sell, they trigger a plunge in asset prices. And the Fed once again finds itself struggling to contain a financial crisis.
Fairfax Media Management Pty Limited
Document AFNR000020150730eb7v0001p
671 words
31 Jul 2015
The Australian Financial Review
AFNR
English
The US central bank has only given itself a grade of 50 per cent in its latest scorecard, believing that although it has succeeded in reviving the flailing US jobs market, it has failed to do the same with inflation.
But while most of us would start looking for another job after such a mediocre performance review, the US Federal Reserve need have no such fears.
Indeed, investors cheered the statement put out after the Fed's latest policy meeting, believing that it pushes the date for any interest rate rise even further into the future.
By highlighting the patchy progress it is making in achieving its "dual mandate", the US central bank has given itself an excellent excuse if it decides to postpone the difficult decision of whether to raise interest rates until 2016.
Janet Yellen, the Fed's chairwoman, has previously warned investors to expect rate rises this year, although she has always added the caveat that the Fed would look to the economic data before moving its key interest rate, which it has kept close to zero since December 2008.
And at this stage, the data is giving decidedly mixed signals. On the unemployment front, the Fed has reason to boast, with the US jobless rate almost halving from 10 per cent in 2009 to 5.3 per cent in June.
In its latest statement, Fed officials congratulated themselves on the "solid job gains and declining unemployment". They also pointed to the pick-up in hiring and the reduction in the amount of slack in the labour market, suggesting that they believe the economy is getting closer to their full employment goal.
But Fed officials had no choice but to concede that they have failed in their attempts to fan price pressures. The Fed's favourite inflation measure remains stuck below 2 per cent - where it has been for three straight years.
Even worse, there are more deflationary pressures brewing. The sharp slowdown in China has caused commodity prices to tumble. At the same time, the stronger US dollar has sliced the cost of imports, putting pressure on US producers to cut prices to maintain market share.
After its meeting in June, the Fed hopefully noted that energy prices had stabilised, which suggested that it was hopeful that the downward price pressures from lower oil prices were fading. But the sharp drop in the oil price in the past few weeks meant there was no mention of stable energy prices in Wednesday's statement. Instead, the Fed warned that it would continue "to monitor inflation developments closely", a sign of its concern that price pressures continue to languish. Rates would only rise when the Fed is "reasonably confident" that inflation will move back to its 2 per cent target.
But the Fed's critics believe that the US central bank - and particularly its policy of keeping interest rates close to zero - is itself to blame for the dearth of inflation.
They argue that artificially low interest rates encourage investors to borrow money and buy existing assets, such as real estate, that already generate dependable income streams, rather than take the risk of investing in new plant and equipment that create jobs.
What's more, they encourage the misallocation of resources. It's unlikely that the US oil and gas exploration boom, which saw US investment banks making around $1 trillion in loans to energy companies (most of which they then sold to investors) would have been possible without such extremely low interest rates.
But such massive misallocation of capital causes the economy's growth rate to tumble, even though debt levels continue to rise.
Eventually, they warn, the economy reaches a point- even with interest rates close to zero - where the return on capital is less than the cost of capital. As nervous investors start to sell, they trigger a plunge in asset prices. And the Fed once again finds itself struggling to contain a financial crisis.
Fairfax Media Management Pty Limited
Document AFNR000020150730eb7v0001p