FOMC to evaluate whether employment and inflation are growing as per expectations
Fed Chairperson Janet Yellen stated on February 14th, 2017, that the Federal Reserve will likely need to raise interest rates at an upcoming meeting, although she flagged considerable uncertainty over economic policy under the Trump administration. Yellen told the US Senate Banking Committee that delaying rate increases could leave the Fed’s policymaking committee behind the curve and eventually lead it to hike rates quickly, which she said could cause a recession. Yellen did not specify when the next rate hike would happen, but said that the Federal Open Market Committee (FOMC) would evaluate whether employment and inflation are evolving in line with its expectations before hiking rates again.
Yellen, who appeared in Congress for the first time since Republicans gained power, acknowledged the uncertainties over the direction of the US economic policy. Yellen also did not say if Fed policymakers expected the economy would warrant three interest rate increases in 2017, as they last signaled in December 2016. She also did not any give indications whether the first rate hike of 2017 might come at its next meeting in March 2017 or at the June 2017 meeting, which is when most analysts expect a rate increase. Since the end of the 2007-09 recession, the Fed has raised rates in December 2015 and again in December 2016.
The FOMC, which met in Washington on December 13th-14th, 2016, increased its benchmark rate by a quarter percentage point to a range of 0.50% to 0.75% for the first time in 2016. The Fed has also indicated that it expects to hike rates three more times in 2017, two or three in 2018, and three in 2019, as inflation expectations have increased considerably along with the strengthening of labor market conditions. New projections show that central bankers are expecting three quarter-point rate increases in 2017, up from the two seen in the previous forecasts in September 2016. Fed officials had left unchanged the target range for the benchmark federal funds rate at a range of 0.25% to 0.50%, where it has been since December 2015, at all its six meetings held in 2016.
The rate increase was only the second in Yellen’s nearly three-year tenure as Fed chair, underscoring her strategy of gradualism in the FOMC’s policy decisions. The unemployment rate was 6.7% when Yellen took office in February 2014, and it is now at about 4.6%. Overall, the FOMC continues to expect that the evolution of the economy will warrant only gradual increases in the federal funds rate over time to achieve and maintain maximum employment and price stability. Meanwhile, Fed officials have reiterated that near-term risks to their outlook are roughly balanced, while projecting three quarter-point rate increases in 2018, based on median federal funds forecasts of 1.375% in 2017 and 2.125% in 2018.
Trump announces rollback of financial regulation
President Donald Trump has announced a rollback of financial regulation with few details and no clarity on the size and scope of the tax cuts that he had earlier promised. The Trump administration has however said that new taxes on imports and increased infrastructure spending could boost inflation. In January 2017, the inflation rate increased 2.5%, following a 2.1% rise in December 2016. The inflation rate accelerated for the sixth consecutive month to the highest since March 2012, mainly boosted by gasoline prices.
While not contemplating on specific tax and spending proposals, Yellen urged policymakers to consider the importance of making US businesses more efficient, which economists believe is essential to raising living standards over the long term. She also stressed on the importance of fiscal policy changes being consistent with putting US fiscal accounts on a sustainable trajectory.
Normalizing unemployment rates
The unemployment rate, which stood at 4.8% in January 2017, is more than 5% lower than where it stood at its peak in 2010 and is now in line with the median of FOMC’s estimates of its longer-run normal level. Data released by the Labor Department on February 3rd, 2017, showed that US job growth surged more than expected in January 2017 as construction firms and retailers ramped up hiring. Nonfarm payrolls increased by 227,000 jobs, the strongest job growth in four months, and followed a 157,000 rise in December 2016. The unemployment rate, however, rose one-tenth of a percentage point to 4.8%.
However, wages barely rose, posing a challenge to the Trump administration as it seeks to deliver 4% annual gross domestic product growth, largely on the back of a plan to cut taxes, reduce regulations, increase infrastructure spending, and renegotiate trade deals in favor of the US. However, with the economy nearing full employment, some economists are skeptical of the 4% growth pledge. Annual GDP growth has not exceeded 2.6% since the 2007-08 recession.
Meanwhile, Trump has proposed an expansionary fiscal policy stance, which could increase the budgetary deficit. Combined with faster economic growth and a labor market that is expected to hit full employment in 2017, it could raise concerns about the Fed falling behind the curve on interest rate increases. A broader measure of labor underutilization, which includes those marginally attached to the labor force and people who are working part time but would like a full-time job, has also continued to improve over the past year. In addition, the pace of wage growth has picked up relative to its pace of a few years ago, a further indication that the job market is tightening.
Encouragingly, policy makers see GDP growing 2.1% in 2017, up from a previous forecast of 2%, while slightly reducing their outlook for unemployment to 4.5%. The median projection for the longer-run federal funds rate increased to 3%, a small shift from about 2.9% in September 2016.
At its meeting on January 31st and February 01st, 2016, the Fed left interest rates unchanged. The focus now shifts to the Fed’s next meeting on March 14th-15th, 2016, where officials will assess the economic scenario before taking the decision to hikes rates if needed.