Fed says rate hike next month hinges on market volatility

29 Aug 2015 | Author: | No comments yet »

Fed vice chair in spotlight as markets seek rate hike clues.

THE UPWARD revision to American GDP on August 27th provided a shot in the arm to global stockmarkets, which have endured their most volatile week of trading in years. WASHINGTON — What once seemed a sure bet — that the Federal Reserve would raise interest rates in September — appears less certain after a wild week of stock market turbulence.Federal Reserve Vice Chairman Stanley Fischer on Friday left open the option of an interest rate increase next month, while two other Fed officials raised the prospect that action would be taken in October.

The American economy is now thought to have grown by 3.7% at an annual rate in the second quarter, a much higher estimate than the 2.3% that was given in an initial evaluation of the quarter. Policy makers, over the past few months, had signaled as much as the US economy continued to grow steadily and the unemployment rate continued to fall. Here’s how it works: Initially, a flurry of news stories appear about how, a few months hence, the Fed intends to raise short-term interest rates for the first time in years. Fischer was the most senior Fed official to speak Friday during a barrage of live television interviews at the Kansas City Fed’s annual retreat in Jackson Hole, Wyo., as policymakers debated what market turmoil means for the U.S.

After so much bad news about the Chinese economy, which has been a factor behind the meltdown of Chinese share indices, the US figure came as a relief to markets. After last week’s gyrations in global stock markets, largely tied to fears about China’s slowing economy, the debate over whether the Fed should hike rates was renewed. Second, the predictable market swoon, as Wall Street traders ponder the fact that the morphine drip of free money that they have been enjoying since the aftermath of the 2008 financial crisis might be pulled out of their arms. European central bankers will address the conference Saturday, providing an international perspective on market convulsions and slower Chinese growth during a panel on global inflation, in which Fischer will also take part. “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,” he said. “I wouldn’t want to go ahead and decide right now what the case is, more compelling, less compelling,” for a September increase.

Finally, the Fed backs away from its much-overdue policy change, causing traders to rejoice and the artificially stimulated bull market in both stocks and bonds to continue. In an interview Friday with CNBC, Fischer said that before the recent market volatility, “there was a pretty strong case” for a rate hike at the Sept. 16-17 meeting. It also began a program with the Orwellian name of quantitative easing — buying huge sums of bonds to suppress long-term interest rates and stimulate lending and spending. There’s simply no need for the Fed to keep propping up the economy with such low rates. ‘You look around Boston and other cities, like New York and San Francisco, and you see the effects — all the commercial construction going on, being built with cheap money.

This was a bonanza for those who make money from money — hedge-fund managers, private-equity moguls, banks — and a disaster for savers, retirees and anyone on a fixed income. (Have you checked the interest your bank pays you on your savings account? Some quick-and-dirty analysis of the data suggests that whenever the Fed changes rates, the Bank of England has a 23% chance of also changing rates (in the same direction) in the subsequent three weeks. Bernanke reaffirmed that decision: The Fed, he said, “currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.” Before the afternoon was out, the Dow Jones industrial average had fallen more than 200 points, or 1.4 percent, and the bond market tanked as the yield on the 10-year Treasury bond rose to 2.36 percent, its highest level since March 2012. Atlanta’s Dennis Lockhart said that “October is a live meeting, it’s in play.” “The fundamentals of the economy are really solid,” Lockhart told Bloomberg Television on Friday at Jackson Hole. “I weigh both the distance that we have traveled as well as the current outlook for the economy. Based on futures prices, investors see a 38 percent chance the Fed will move at the September meeting of the Open Market Committee and a 49 percent probability of a rate rise at the Oct. 27-28 meeting, according to Bloomberg.

The case for raising rates is straightforward: Like any commodity, the price of borrowing money — interest rates — should be determined by supply and demand, not by manipulation by a market behemoth. Essentially, the clever Q.E. program caused a widespread mispricing of risk, deluding investors into underestimating the risk of various financial assets they were buying.

Inflation, they add, is so low that a shock that further weakens the economy could lead to deflation, the destructive cycle of falling prices and wages, and high unemployment. More recently, Japan has struggled for the better part of the last two decades to break a cycle of deflation and anemic economic growth. “Inflation is simply not a threat right now,” said Barry Bosworth, an economist at the Brookings Institution, a Washington think tank. “I just don’t see any pressing reasons why the Fed needs to raise rates now.” Brian Bethune, an economist at Tufts University, said he worries that raising interest rates now might further strengthen the US dollar, making American-produced goods more expensive overseas and hurting export sectors such as manufacturing and agriculture.

The worsening economic news from China, combined with uncertainty about the Fed’s plans, contributed to the recent sharp declines in stock markets around the world. Around then came a leaked note to clients from Ray Dalio, founder of Bridgewater Associates, one of the world’s largest hedge funds, agreeing with Mr. He warned that the Fed might be so wedded to its “highly advertised tightening path that it will be difficult for them to change to a significantly easier path if that should be required.” This elite pas de deux reached a crescendo on Wednesday when William C. The argument for doing so, he said, seemed “less compelling to me than it was a few weeks ago,” noting that “international developments have increased the downside risk to U.S. economic growth somewhat.” Once the news of Mr.

The gathering’s theme is the boring-sounding “Inflation Dynamics and Monetary Policy,” but it’s the perfect setting for these supposedly brilliant economists to figure a way out of this perennial Catch-22 once and for all.

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