“To raise or not to raise rates? That is the question.” Okay, William Shakespeare we are not, but for the month of September, we did feel quite the effects of the Fed’s decision to refrain from raising interest rates for now. This left the rest of the financial world to wonder about the Fed’s outlook and concern over the perceived health of the US economy. During a recent press conference Fed Chair Janet Yellen stated that, while the US economy was “sufficiently” strong to handle an interest rate increase, she was concerned that other parts of the world were not in the same economic position. Financial markets have since reacted quite negatively to this “new” news from the Fed. So the financial markets asked a question of their own. “What does it (the Fed) know that we don’t know? That is the new question.” Touché, financial markets.
The Fed’s “dual mandate” means that it has always been focused on managing inflation while pursuing full employment, but after September’s Federal Open Market Committee meeting, some have feared that the Fed introduced a new third mandate – global growth. Yellen mentioned in her September press conference that, "heightened concerns about growth in China and other emerging market economies" weighed on the decision to leave rates unchanged in September. But her emphasis was not on boosting global growth. Rather, she and her colleagues wanted to wait for signs that the US economy might be negatively impacted. At the time of the meeting, the Fed’s outlook for the US economy had not changed and several days later she confirmed the Fed’s expectation to raise rates later this year.
The takeaway is that global concerns, translated as China, are weighing more heavily on Fed policy than they had before—but not for the reasons feared. Yellen is justified in looking at global growth trends when they could negatively impact US growth (and employment). In her second speech mentioned above, she strongly reinforced that the Fed is following the dual mandate established by Congress. Fears will likely continue, however, that given the complex interactions within a globalized economy, the Fed will be tempted to weigh its decisions in light of the global implications.
Equally interesting is the apparent tension between the timing of the first rate hike (liftoff) and the speed with which rates are raised thereafter (trajectory). Chair Yellen has argued for most of this year that trajectory was more important than lift off, but having delayed a rate increase for the second time, it is clear that in her mind liftoff rules the day. For this reason, we should have at least some level of comfort that when it finally does occur, liftoff will be a positive indicator for the outlook of the US economy.
Supporting the Fed’s outlook for a strengthening economy is the most recent housing and automotive data and broad employment trends. The sentiment index of the National Association of Home Builders rose to its highest level in years along with strong single-family home sales. Automotive units sold for the month of September exceeded expectations, putting the auto industry on pace for its best year since 2000. While the US employment report for September was bad, the trend in several leading employment indicators continue to be positive. All of this suggests that the US consumer is alive and well. Of course the consumer is benefitting from the effects of a strong dollar and lower energy and commodities prices. These benefits continue to show themselves in lower gas prices, which are helping auto and hospitality sales, and lower prices of imported goods, which are boosting strong earnings for retailers. We are, however, keeping our eye on manufacturing, as several manufacturing indicators are showing little sign of economic expansion.
To be forward looking, we do believe that the Fed is intent on raising rates soon, and we agree with its stronger US economic outlook. But the Fed may be wary of any potential impacts that US rate increases can have on the rest of the world if those impacts can turn around and hurt the US economy. Now as to whether the Fed will pursue a “new third mandate” as central banker to the world, only time will tell. We have learned that both William Shakespeare and Janet Yellen have one thing in common: a flair for the dramatic!