Keep the Real Economy in Focus, Not Just the Fed

Jeremy Glaser:For Morningstar, I'm Jeremy Glaser. The Federal Reserve didn't raise rates at their September meeting but seemed to be open to the possibility of a December rise. I'm here with Bob Johnson, he's our director of economic analysis, for his take. 

Bob, thanks for joining me.

Bob Johnson: Great to be here today.

Glaser: So going into this meeting, expectations were pretty muted that there was going to be an increase and that's exactly what we saw.

Johnson: Absolutely. I think that they left the door open for some increases later in the year. In fact, if the economy progresses as they expect, their expectation is that we probably have one rate increase this year, probably, at the December meeting. So, it was pretty much as scripted.

Glaser: So what held them back? Was it just some of those weak labor market reports or do you think there were other things happening there?

Johnson: Well, I think that they thought things were strengthening but they just hadn't seen enough strength to cause them to act. They weren't particularly scared at the moment.

Glaser: So it seems like the goal posts are moving a little bit. We've reached a lot of the metrics on inflation, but at least unemployment that they're looking for over the long term. What would have to happen between now and December in order to make them feel comfortable enough to actually raise rates?

Johnson: Yeah. I think the key thing would be continued improvement in the labor market, and I think they would have to see an increase in inflation as well. Maybe, one of the things that might be holding them back is that we've definitely had some food deflation in there that's really helped keep a lid on the overall inflation number, and I think that's probably  given them a little bit more flexibility in their numbers. Again, I think if inflation were to spike up, if the economy continues to strengthen, those would be all things that would cause them to act in December, but you always get it with a caveat. So, what's happening in the rest of the world? That could always hold them back as well.

Glaser: Now, before the meeting, we talked a little bit about how you do see some signs of weakening of the economy. Do you think there's a chance that December is not a done deal, that we could see zero increases in 2016?

Johnson: I think that's a real possibility. I hate to say it. When the economy was looking a little bit stronger six, nine months ago, maybe that would be the right time to put a little cushion into their numbers and start raising rates. But now they've put it off this long and then now, it looks like we're getting near the end of the recovery and a lot of things are slowing. This week, there was even more of that. Architectural billing index dropped below 50, a key indicator of business spending on buildings. I'm just very worried about the data. We've also seen the restaurant business begin to turn in signs of weakness as the gap between the price for grocery prices and food prices out, diverge. We've seen a shrinkage in restaurant spending, and that's obviously helped drive the labor market and helped numbers overall. And so, there are a number of things that really look quite weak to me, here. And even the housing starts and permits data was nothing to write home about. All of that tells me the economy is likely to slow. I think the Fed said as much in some of their forecasts as well.

Glaser: We did get this forecast along with the statement. They say this is what we think is going to happen with the economy. Even in the longer run, they see growth as being pretty slow. Is that something that should be concerning?

Johnson: It should be concerning. It's something that we've talked about. It's just a matter of trying to figure out where the bottom and what the offsets might be. But for this year, 2016, they dropped their forecast from 2% to 1.8%. So, recollect we're in the range of 1.5% to 2% for this year, so they've dropped back into the middle of our range. And I'm even thinking more like 1.5% than 2%, so I think they're probably still going to end up being a little high. They kept the next two years the same, with some hopes that maybe, there's just a temporary thing in there. I don't think so. But they did pull down their long-term growth rate for the economy from 2% to 1.8%, which makes a lot of sense given the demographics.

Glaser: So, overall, you think this was expected, December possibility not a done deal, and the real thing investors should be thinking about is what's happening with longer-term growth, not what's happening with rates.

Johnson: Absolutely. They're watching a side show here while the real economy is continuing to weaken here, and I would be very, very concerned about that.

Glaser: Well, Bob, as always, we appreciate your analysis.

Johnson: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.