RBI governor cautions US Fed against raising rates

29 Aug 2015 | Author: | No comments yet »

Fed vice chair in spotlight on possible rate hike.

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.

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. It’s not worried about deflation, India is growing twice as fast as the US, and interest rates sit around 7 percent. “My position over time has been don’t do it when the world is in turmoil,” he told CNBC’s “Closing Bell” Friday. “It’s a long anticipated event, it has to happen sometime—everybody knows it has to happen—but pick your time.” For now it doesn’t appear as though that decision has been made ahead of the Fed’s mid-September policy meeting. 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. 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. However, Larry Summers and other prominent market watchers have made that very case, claiming a rate hike in a period of increased volatility and collapsing commodity prices would strengthen the dollar and send global markets back into a downward spiral. 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.

But the central banker believes drawing the line from a stronger dollar is not so simple. “[A strong dollar] does cause some fragility, but on the other hand if it’s accompanied by very strong U.S. growth it does help other countries who can then export to the United States and pick up their own economies on that basis,” Rajan said. Second-quarter GDP growth was revised higher on Friday to 3.7 percent from 3.2 percent, potentially boosting the probability of a September rate hike that many heavily discounted after China devalued its currency. Fischer said Fed officials realize that they need to act before data requires them to hike rates to alleviate inflation: “When the case is overwhelming, if you wait that long, you will be waiting too long.” 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. Those who oppose raising rates at this point say, yes, the US economy has improved, but it’s still fragile and recent world events make it vulnerable to a possible slowdown — or worse. 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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