In December 2015, the U.S. Federal Reserve raised the key interest rates for the first time in almost a decade. The raising of interest rates was the Fed’s way of signaling its confidence in the bullish outlook for the U.S. economy. However, the Fed might no longer be as bullish on the U.S. economy as it was when it decided to raise interest rates last year.
The unrestrained drop in global oil prices and the inability of oil producing countries to reach an agreement on the need to reduce the production and supply of oil makes the outlook gloomy. Equity markets are suffering globally and the U.S. stock market has imported some of the volatility from stocks in Europe and Asia. This piece seeks to explore how recent revelations from the Fed might suggest that the U.S. economy is in for a rough ride in 2016.
Fed tones down bullish tone
Minutes of the Fed’s January 27 meeting has been released and the content of the minutes echoes the fears of Janet Yellen in her testimony before congress last week. The Fed thinks that recent volatility in global markets could cast dark shadows on the previously bright outlook of the U.S. economy. The Fed noted that the sustained drop in oil prices has placed a lid on inflation and there’s not much that it could do if inflation doesn’t pick up.
The Fed noted that the troubles in the domestic market and in the global markets coupled with falling oil prices “have the potential to further restrain domestic economic activity.” The minutes went ahead to say, “the implications of the available information were not sufficiently clear to allow members to assess the balance of risks to the economic outlook,” but the Fed officials “observed that if the recent tightening of global financial conditions was sustained, it could be a factor amplifying downside risks.”
The Fed is notorious for avoiding language that might make a direct connection between global economic problems and U.S. economic outlook – the fact that the Fed is making the connection now suggests that the Fed might be at loss for what to do. Barclays Capital opines that the Fed will not react to the current market dynamics and that the Fed will only act after it has a firm grasp of the trends in the global economic outlook. In the words of the analysts, “in our view, this statement implies that the committee expects to be on hold until financial conditions improve.”
A March rate hike is uncertain
The Federal Reserve raised interest rates in December 2015; the consensus forecast on Fed’s interest rate policy was that there would be about four rate hikes in 2016. In fact, market watchers expected the Fed to raise interest rates by 0.25% each time with the first rate hike slated for March 2016. However, recent revelations from the minutes suggest that the Fed might not be inclined to raise interest rates any time soon.
The Fed said it is “closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of the risks to the outlook.” It also appears that investors are not keen on seeing additional rate hikes because U.S. equities crashed on Thursday after news broke that the Fed might be having a rethink on raising interest rates. For instance, the Dow Jones Industrial Average was down 0.25%, NASDAQ Composite was down 0.47%, S&P 500 was down 1.03 % as at market close on Thursday.
Apart from the fact that the Fed might not be raising interest rates in March – another troubling fact is that the Fed might now be considering negative interest rates. A negative interest rate situation means that you’ll pay the bank to keep deposits – people would not want to pay interests on deposits; hence, negative interest rates can trigger increased economic spending.
During Yellen’s testimony before Congress last week, she was asked if recent global economic concerns would stop the plan to raise interest rates gradually and she replied that “the answer is maybe, but the jury is out.” When she was asked if the Fed would consider negative interest rates, she answered that the Fed was looking at negative interest rates as a possible option.