The exact date of the rate liftoff is of little consequence to broader macroeconomic performance, according to a Dun & Bradstreet analysis. What is of greater importance is the trajectory of the policy rate and the pace of subsequent rate increases, as these factors do more to help define monetary policy, guide the economy’s expansion, and inform business planning.
The business community and the general public remain unduly focused on whether the Fed will opt for the first rate hike at the Federal Open Market Committee (FOMC) monetary policy meeting in September or at the one in December. Whatever the exact date, businesses should prepare for rates to rise by the end of the year.
We expect subsequent increases in the Federal Funds Rate (FFR) to follow a shallow path, reaching only 1.0% at the end of 2016. Even after the Fed begins the process of interest rate normalization, monetary policy will remain very accommodative for an extended period of time.
Two sets of data are at the heart of the speculation regarding the Fed rate liftoff. The first, more recent development relates to China. The second relates to growth in the real economy.
The devaluation of the Chinese yuan and the massive selloff in the Chinese stock markets sparked a correction in US equity markets, ignited volatility in global financial markets, and led many to believe that the Fed will postpone liftoff from September. While the Fed remains watchful of conditions in global markets, the stock market is not the real economy, and the underlying implications of equity market turmoil on the real economy will eventually prompt the Fed to decide on a date.
The tremors that originated at the Chinese epicenter are grounded in real slowdown in the Chinese economy, which could eventually become a bigger risk by dragging on overall global growth.
The more immediate effect of financial market fluctuations is likely to be upward pressure on the US dollar, thanks to its position as a safe haven currency. A strong dollar is already one factor preventing domestic inflation, keeping it below the Fed’s target of 2% inflation.
The expectation of inflation is just as important (if not more important) for the Fed than actual inflation; the Fed is not going to wait till the actual inflation rates touch 2% — that would be too late. Additionally, the dollar might actually depreciate following a rate rise.
The second, more fundamental set of data that informs the Fed rate liftoff shows that, underlying the nominal gyrations in financial markets, the real economy continues to grow at a decent pace. This will keep the Fed on track for a rate hike this year. Q2 real GDP growth was revised upwards to 3.7% SAAR as per the Bureau of Economic Analysis’ second estimate, up from 2.3% in the advance estimate.
Revised GDP numbers are unlikely to play a significant role in the decision as to the precise month for the Fed’s liftoff, but it signals to the central bank that the economy remains robust enough to withstand limited external volatility. The labor market, one of the most consistent positives in the economy, added 173,000 new jobs in August, taking the three-month moving average pace of job creation to a solid 221,000. The unemployment rate fell to 5.1%, already below the 5.2%-5.3% range the FOMC had projected it to reach at its last meeting in June.
In summary, we urge our clients to plan for a rate rise this year. The Fed will continue to tailor monetary policy to provide adequate support to the economy. A higher interest rate is not just a step towards normalization of monetary policy; it is also a confirmation of the improvement in the US economic fundamentals, a sign of the Fed’s confidence in the staying power of the economy’s expansion.
Bodhi Ganguli is a Senior Economist on D&B’s Global Data, Insight & Analytics team. Based in Short Hills, NJ, Bodhi covers sub-Saharan Africa as a contributor to D&B Macro Market/Country Insight Products. He is also a member of D&B’s US Economic Advisory Panel. He received his Ph.D. in economics from Rutgers University and his bachelor’s degree in economics from Presidency College, India.