On Friday, Federal Reserve Chairwoman Janet Yellen told global monetary policymakers, “I believe the case for an increase in the federal funds rate has strengthened in recent months.” She implied that internal forecasts have indicated steady growth, unemployment and inflation.
After her comments, traders put a 24 percent probability on a Fed rate increase in September and a 57 percent probability for a raise by December.
Yellen pointed out that she expected the economy to continue to grow at a deliberate pace. She did mention areas of concern: Business investment has been weak and exports have been hurt by a strong U.S. dollar.
The argument for raising rates sometime this year will largely depend on maintaining monthly job growth, which has averaged 190,000 a month year to date. The unemployment rate currently is 4.9 percent — a very respectable level.
Despite Yellen’s comments, many investment professionals remain skeptical that the Fed will indeed raise rates that soon. Their doubts arise primarily from the wide gap in the past few years between what has been indicated and what has transpired. Let me explain.
Last December, the prevalent outlook was for four increases in 2016. To date, we have had only one because of the global slowdown, the financial market volatility and the slow progress in meeting the Fed’s goal for inflation to be 2 percent.
The U.S. economy’s performance has been mixed. While consumers have ramped up spending, business investment has declined, in part because of declining profits caused by the strong U.S. dollar and weak oil prices. The U.S. economy has been stalled in the slow lane for the past year. Gross Domestic Product advanced at a modest pace of 0.9 percent in the fourth quarter of 2015 and 0.8 percent in the first quarter of 2016.
Fed Governor Jerome Powell told Bloomberg Television on Friday that the Fed should be patient and that he wanted to see inflation increase before he supports raising rates.
“When we see progress toward 2 percent inflation and a tightening in the labor market and growth strong enough to support all that, we should take the opportunity (to raise rates),” Powell said.
Yellen in her speech gave a wide range of forecasts of where the Fed’s interest rates will be in the coming years. While the Fed rate has been near zero for some eight years, Yellen indicated that Fed officials forecast a 70 percent probability that they will be 0 to 3.75 percent at the end of 2017 and 0 to 4.25 percent at the end of 2018.
As of June, the median estimate for the federal funds rate at the end of 2017 was 1.625 percent and for 2018 was 2.375 percent.
Given the prevalence of near-zero rates for almost eight years, I am flabbergasted at the range of rates Yellen estimated on Friday. First of all, I find it amazing that she hedged her prognosis about future Fed rates by using the 70 percent number instead of 95 percent. Secondly, after so many years of unchanged rates, I cannot imagine Fed funds jumping above 2 percent by the end of 2017, let alone going to 3.75 percent.
To get significantly higher rates, Europe, China and Japan would all need to enjoy an economic boom that appears unlikely. Stated differently, while most analysts have concerns about our near-zero rates, they would also be unhappy about significant increases. They point out that businesses prefer making investments under stable economic conditions.
In recent years, critics of the Fed have argued that it operates without transparency. I would argue that in the interest of full disclosure, Yellen should have shared the conditions under which Fed funds could rise above 3.75 percent.
Originally published in the Sarasota Herald-Tribune
