China turmoil divides Fed over inflation

31 Aug 2015 | Author: | No comments yet »

Editorial: Memo to Fed: It’s OK.

After a tumultuous week on the world’s stock markets, investors will be focused on Wall Street Monday ahead of another set of economic reports likely to steer the Federal Reserve’s decision on whether to raise interest rates for the first time in almost a decade. Jackson Hole, Wyoming: The Federal Reserve on Friday left the door open to a September interest rate hike even while several US central bank officials acknowledged that turmoil in financial markets, if prolonged, could delay the first policy tightening in nearly a decade.

Some top policymakers, including Fed vice-chairman Stanley Fischer, said recent volatility in global markets could quickly ease and possibly pave the way for the US rate hike, for which investors, governments and central banks around the world are bracing. Fischer said there’s “good reason to believe that inflation will move higher as the forces holding down inflation dissipate further.” He said, for example, that some effects of a stronger dollar and a plunge in oil prices — key factors in holding down inflation — have already started to diminish.

In a speech on Saturday, Stanley Fischer, the vice-chair of the Fed’s Board of Governors, suggested inflationary pressures could soon lead to an increase. Markets will therefore be watching business surveys, factory orders and trade data from the world’s largest economy as well as the employment numbers due on Friday. “The week finishes with non-farm payrolls for August, typically the biggest market mover globally, and definitely on the Fed’s radar given unemployment is already close to full employment and the Fed looking to gauge whether there is `some’ further labour market improvement,” economists at National Australia Bank said. If rates don’t rise at least a bit, businesses and consumers will conclude that the Fed still expects choppy economic waters and will pull in their only recently extended horns. Hundreds of billions of dollars were wiped out and, mostly, gained back on stock markets across the world last week as traders and investors panicked about a possible slowdown in the Chinese economy, the world’s second-largest. US stock indexes ended largely unchanged, capping a week that included both the market’s worst day in four years and biggest two-day gain since the 2007-2009 financial crisis.

In New York, the Dow Jones industrial average index lost 1,000 points last Monday – a day dubbed Black Monday by Xinhua, China’s official news agency. On Friday, the Dow closed down marginally for the day but up 1.1% for the week after rallying for two days on comments from Bill Dudley, the president of the New York Federal Reserve and the second-most important US central banker after Janet Yellen. Louis Fed President James Bullard told Reuters he still favoured hiking rates next month, though he added that his colleagues would be hesitant to do so if global markets continued to be volatile in mid-September. Michael Hanson, senior economist at Bank of America Merrill Lynch, saw Fischer’s remarks as an explanation of why the Fed might not wait for inflation to move closer to 2 per cent before raising rates. The Fed’s policy committee “does not like to move right in the middle of a global financial storm,” Bullard, a Fed hawk, said in an interview. “So one of the advantages we have is that this storm is occurring now and, at least as of now, we think it will be settled down” by the September meeting.

John Silvia, chief economist at Wells Fargo, said that based on Fischer’s comments, he thinks the first rate hike will come next month if the August jobs report that will arrive Friday is strong and financial markets settle down. The Commerce Department’s routine revision of second-quarter data showed the economy rising at an annual rate of 3.7 percent, far better than the 2.3 percent of the first assessment. He repeated the guidelines the Fed is using to determine when to raise its key short-term rate, which has been held near zero since 2008 and has helped keep borrowing rates low throughout the economy. The prospect of a rate increase by the Fed has also alarmed global stock markets, because it could draw investment funds out of emerging markets and back to the US. The European Central Bank is expected to keep a steady hand when it meets on Thursday, days after data are likely to show there is still very little inflation in the currency bloc.

Almost half a year since the ECB started pumping 60 billion euros a month of fresh cash into the economy, annual inflation data, due on Monday, will probably still show prices rose only 0.1 percent in August – nowhere near the bank’s 2 percent target ceiling. The US government reported this week that the economy grew at a 3.7 per cent annualised pace in the second quarter, sharply higher than its previous estimate, and that consumer spending, which accounts for more than two-thirds of economic activity, rose again in July. The annual retreat to Jackson Hole, Wyoming, which has in previous years been dominated by discussion about the oncoming collapse of Lehman Brothers in 2008 and the Greek debt crisis, this year focused on what impact a Chinese slowdown could have on the US economy. There is a growing chance the ECB will extend its stimulus programme beyond the planned completion in September 2016, and if inflation data misses expectations that likelihood will only increase.

But after Fischer spoke, traders added to bets that a rate hike would come this year, with overnight indexed swap rates implying a 35 per cent chance the Fed would move in September and a 77 per cent chance of a December move. Atlanta Fed President Dennis Lockhart, a centrist who has become less resolute about a September rate hike as markets have tumbled, told Bloomberg TV that it was reasonable to see the odds of a move next month as roughly even.

Before the meeting, Fischer had said it was too early to say whether the market turmoil had had an effect on the decision. “I think it’s early to tell: the change in the circumstances which began with the Chinese devaluation is relatively new and we’re still watching how it unfolds, so I wouldn’t want to go ahead and decide right now what the case is – more compelling, less compelling, et cetera,” he told CNBC. The Fed decision has drawn unusually intense interest from both foreign central bankers, who will have to respond, and from Americans on both the right and left. Last month, non-farm payrolls increased by 215,000 as a pickup in construction and manufacturing jobs offset further declines in the mining sector, and figures for previous months’ reports were revised up.

Meanwhile, a floor below the main Federal Reserve conference space, the Center for Popular Democracy hosted workers and economists calling on the Fed to keep rates low to get more Americans back to work. The Fed needs to rethink “full employment in a way that recognises the high joblessness of black and Latino communities,” Sarita Turner of PolicyLink told about 60 advocates, noting that US joblessness among blacks is twice that of whites.

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