Although overseas concerns halted Fed action this month, a hike is still in the cards this year--but it shouldn't derail the economy, say Morningstar's Bob Johnson.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. The Federal Reserve held rates steady in its September meeting. I'm here with Bob Johnson--he is our director of economic analysis--for his take on the release and also the press conference afterward.
Bob, thanks for joining me.
Bob Johnson: Great to be here today.
Glaser: So, there was a chance that the Fed was going to raise rates in September. They chose not to. What held them back? Why do they think the economy isn't quite ready yet?
Johnson: I think they were really clear that U.S. conditions were pretty good--maybe they could be a little better in a couple of areas--but the key thing was international developments. There, they made it very clear that they weren't trying to help the other world economies but that they were fearful of what would happen to U.S. net exports if the rest of the world continued to slow--especially China. So, I think that was the main thing that held them back--international activity. Again, it wasn't an act of altruism; it was something to protect our economy and our growth rate here in the U.S.
Glaser: They mentioned that financial conditions were another thing that concerned them. Do they see some of the volatility we've seen in the stock market as a problem or is it the underlying issues with the global economy that they are more concerned about?
Johnson: I think they are much more concerned about the global economy. They can't worry about the individual movements in stocks and stock market volatility, but they are very concerned about the overall economic activity and what that might mean.
Glaser: Along with these releases we also see what the Fed thinks the path of future rate increases will look like. Any changes there--any surprises?
Johnson: Well, you mentioned at the beginning that they kept the Fed-fund rate, which is the key thing they control, at the 0% to 0.25% range. What they did was they said that they were keeping that, but they also indicate what each of the governors thinks going forward--not by name, but they do a dot plot of where everybody thinks things are going to be. Thirteen of the 17 governors still believe that we'll have a rate increase sometime in 2015, so that's not all that far out. I think people still believe that it will happen. A small nuance: There were even more who thought this was going to happen in 2015 at the last major meeting. So, slightly fewer felt that they would be raising rates; but still, 13 out of 17 is a pretty hefty number.
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Glaser: When you look out on their expectations for years to come, what do you think the path of rates is? How fast do you think they are going to have to raise rates when they start?
Johnson: This has got to be one of the slowest trajectories that we've seen in some time. Usually within a couple of years, the rates go up 3% or 3.5%--sometimes even more than that in the Fed-funds rate. Right now, the trajectory is maybe 0.4% by the end of this year--implying one rate increase--1.4% for the end of 2016, and 2.6% by 2017. So, it's a very slow and measured trajectory of interest-rate increases.
Glaser: Looking at their other projections, what do they see happening in terms of growth in the U.S. economy?
Johnson: That was kind of a mixed bag there. They had almost a silly number for 2015. They previously had a 1.9% growth rate. They have raised that to 2.1% now--that's fourth-quarter-to-fourth-quarter GDP growth rate. I still think that is way too low; but in any case, they did move it back into that 2% to 2.5% range that we've been talking about for so long. And frankly, the out years are also going to be in that 2% to 2.5% range. Some of those numbers are slightly lower than they were before in terms of a growth rate. But again, they did raise it on the front end of the curve here in 2015.
Glaser: On the employment front, the unemployment rate, at 5.1%, is near the long term of where the Fed wants it to be. Why do they still want to see further improvement in jobs? That came up a few times. What else is the committee looking for?
Johnson: They are pretty good with the jobs number in a general way, but they are kind of interested that the wages really haven't gone up. So, maybe this isn't the best metric in the world to use. They said they were also worried a little bit about the participation rate and the number of people who are in part-time jobs that would really rather have a full-time job but just can't find one. So, those things are all in the backs of their minds on the labor market. Again, they have kind of met the targets that they thought they would need to be moving rates back up. But there are a few little question marks on the edges. And if the world economy was booming right now and inflation was headed way back up again, they would be moving [on rates].
This would not be enough to stop them. But inflation, especially the report yesterday, again was a little bit weak on the inflation front. They still believe it's all transitory--that it's mainly energy related and maybe a little bit of a strong dollar and that if that starts to fade, then we'll get back to our core inflation rate of 2% or so. So, they are not really worried about that either. I think clearly the international situation has really got them a little bit on edge.
Glaser: Should they be worried about that inflation number? They said, in the medium term, they want to get to that 2%. Do you see us getting there in the near future?
Johnson: They did a lot of talking around that. They said, "Well, we can't really wait until it gets all the way to 2% because that's going to be too late, but we can't be too preemptive and stop the economy in its track." So, I think they are being a little coy with that, but I think they'd like inflation to be higher than the numbers we are seeing right now. But I think that they don't have to be a lot higher necessarily for them to start raising rates.
Glaser: There are only two meetings left in 2015--in October and December. What kind of data or confirmation could come out in that time period that you think would tip them into actually raising rates this year?
Johnson: I think a really strong inflation report in one of those couple of months that was outside of energy would partly do the trick. A couple of really strong employment reports could also do it. I think those are probably the major things. Obviously, if things start to stabilize overseas a little bit, that would certainly be a help.
It's interesting--I think Europe looks a little better now than it did a few months ago. I think the U.S. looks a little better than it did a few months ago. But the commodities-oriented economies--the Australias, Canadas, and Brazils of the world--are all hurting probably a little bit more than we thought. China is probably a little weaker than we thought. So, there is a world-economy issue out there, but it's not necessarily an all-bad thing for the developed economy. So, it's kind of a mixed bag there.
Glaser: Do you see them increasing this year?
Johnson: I think they will. I even thought there was a 50-50 chance that they would today. But I do think they have to get moving at some because they can't wait until inflation shows up and then have to raise rates 0.5%. That would really foil their whole plan to do this gradual-trajectory thing. And if the economy does soften at some point, they need to be able to bring the rate back down to something. They can't really effectively go much below that zero bound.
So, I really think they need to give themselves some flexibility and slowly move that rate up. A quarter of a percent isn't going to hurt the economy. If credit card rates are 14% or 15%, 0.25% isn't going to make a difference. Even in the mortgage market, I don't think 0.25% is going to be enough to hurt you. Certainly, there are other things like cheap gas prices right now that are driving auto sales, which is also usually a key hurt from [higher interest rates], but 0.25% just doesn't dent any of those.
Glaser: So, an increase in October or December isn't going to make a big difference to the real economy?
Johnson: It's not going to make a big difference to the real economy either way. October is a little harder because of the infrastructure of the meetings--there's a big press conference scheduled after that one. So, it's a little bit harder to raise rates in October. [Yellen] said very clearly that if things got strong enough, they could still do it in October. But it feels like December to me when they've got all of the infrastructure in place. One month hardly strikes me as enough time for things to have changed. We'll just have to see.
Glaser: Bob, I appreciate your analysis today.
Johnson: Thank you.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
