Can the United States Federal Reserve raise interest-rates?

This evening we will see the latest set of meeting Minutes from the Federal Reserve Open Markets Committee which is the interest-rate and indeed Quantitative Easing arm of the US central bank. Rather like the Bank of England the FOMC has been teasing everybody about a prospective interest-rate rise for some time now but just like it nothing has actually happened. It has remained a mirage in the distance that is apparently just out of reach. You might like to contrast that in these times with interest-rate cuts around the world which flash up across the various media with quite some regularity these days So far this year there have been 30 or so interest-rate cuts in 2015 including China, India,Korea, Australia and a host of others including Switzerland, Denmark and Sweden who have plunged into the icy cold world of either negative interest-rates or further into them. You may note that there is quite an asymmetry there!

What about the US economy?

The latest set of economic growth data were poor.

Real gross domestic product — the value of the production of goods and services in the United States, adjusted for price changes — increased at an annual rate of 0.2 percent in the first quarter of 2015, according to the “advance” estimate released by the Bureau of Economic Analysis. In the fourth quarter, real GDP increased 2.2 percent.

So there was not only a very weak reading but quite a slowdown from the end of 2014. This was quite a lurch downwards from the 3% annualised growth that had been doing the rounds in the financial markets not so long ago. Indeed as recently as February the Bank of England made yet another forecasting error.

much weaker than the 0.6% expected at the time of the February Inflation Report (or annualised ~2.5%)

Since then we have seen very poor trade figures thrown into the mix.

The U.S. Census Bureau… announced today that the goods and services deficit was $51.4 billion in March, up
$15.5 billion from $35.9 billion in February, revised

This meant that the quarterly picture for trade was now as follows.

Year-to-date, the goods and services deficit increased $6.4 billion, or 5.2 percent, from the same period in 2014.

Accordingly the latest estimates for that quarter are now in negative territory as we await the later updates. The only hope is that a more complete data set finds a positive nugget or two.

Also as we recall the way that central banks panic at the thought of negative inflation there was this tucked away in the data.

The price index for gross domestic purchases, which measures prices paid by U.S. residents, decreased 1.5 percent in the first quarter, compared with a decrease of 0.1 percent in the fourth.

Ordinary workers and consumers will welcome lower energy and to a lesser extent food prices but of course central bankers are made very nervous by them. What about the banks? What about the debt?

What about now?

Something rather familiar has been happening and I shall take you over to the Atlanta Federal Reserve whose GDP tracker has been on form.

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2015 was 0.7 percent on May 19, unchanged from May 13.

Over the past week the number had been pulled lower by weak industrial production data and then pushed back up by strong residential housing numbers. So there is the distinct possibility that over the first half of 2015 the US economy will see no growth at all. This is very different from what is calls the “Blue Chip consensus” which has gone from just above 3% per annum growth to just below it. Quite a gap! Just like last time.

Ominously perhaps today’s Bank of England Minutes remain optimistic for US economic growth.

These effects were likely to be temporary, pushing up on growth in Q2: Bank staff expected growth of 0.7%.

Ah that word temporary again! Has anything actually proved to be temporary after an official claim about bad data?

As recently as the middle of March the Federal Reserve told us that US GDP growth in 2015 would be between 2.3% and 2.7% which means that it will really have to charge ahead in the second half of this year.

Wage growth and productivity

This is a measure which most central banks are tracking closely right now. The latest employment report data is below.

In April, average hourly earnings for all employees on private nonfarm payrolls rose by 3 cents to $24.87. Over the past 12 months, average hourly earnings have increased by 2.2 percent.

Hardly racing away is it as the last quarter of 2014 saw growth of 2% per annum? If we look back to the pre credit crunch period then depending on which measure you use you would estimate it at being 3-4% per annum.

Also somewhat ominous for possible wage growth is this research from the Atlanta Fed about productivity.

For example, over the past three years, business sector output growth averaged close to 3 percent a year. Labor productivity growth accounted for only about 0.75 percentage point of these output gains.

Thus it is not only the UK which has its concerns about labo(u)r productivity and the new pattern is very different from the past.

Business sector labor productivity growth averaged 1.4 percent over the past 10 years. This is well below the labor productivity gains of 3 percent a year experienced during the information technology productivity boom from the mid-1990s through the mid-2000s.

If these productivity trends are now permanent then real wages are on quite a different path to what people hope they will be and of course the path for interest-rates changes too.

Business surveys

These are hard to read at the moment as highlighted by the latest purchasing managers report from Markit.

The seasonally adjusted final Markit U.S. Composite PMI™ Output Index (covering manufacturing and services) posted 57.0 in April, down from 59.2 in March and the lowest reading for three months.

It would be ominous if there was a slow down from the weak official economic growth data for the first quarter of this year. But as I am sure you have noticed the PMI report had economic growth charging forwards earlier this year!

Monetary Policy has tightened

There is much more to monetary policy than just official interest-rates especially these days. If we look at market interest-rates then the ten-year bond yield has risen from just above 1.6% in late January to 2.27% now. This has pulled mortgage rates back up again after the falls seen in 2014 and January of this year. Whilst the US Dollar is no longer at its highs the trade-weighted dollar index is at 95.5 compared to 80 a year ago which shows how much the US Dollar has risen.

Some care is needed because the US Dollar is the reserve currency and also because the US economy is in proportional terms less of a trade dependent nation than many. But if you were setting US policy you would be wondering if March’s poor trade figures were the beginning of a new weaker trend.


There are many ways of looking at the situation. I have thought for some time that a new version of Forward Guidance is in operation where the Fed (and the Bank of England) promise interest-rate rises but in reality do not actually mean to carry them out. They hope that “expectations” as in market behaviour will do the job for them and make actual rises unnecessary. They of course ignore the dangers of moral hazard and to credibility of crying wolf.

Added to this are signs of weakness from the US economy which are far from alone in the world. For example after a good start to 2015 the Euro area (h/t @markbartontv ) surprise index has not only reversed but gone negative recently. If matters are going so well in China why does it keep cutting interest-rates? Indeed why are so many cutting interest-rates. Now America is often quite insular and may be bothered less by the rest of the world than one might think but it will worry about how much higher the US Dollar would go if it raised interest-rates.

So this is a situation rather like the UK General Election as even those who say they will raise rates are likely to change course when it comes to actually doing so. As Change (with one Luther Vandross) put it.

But now I know
I don’t need you at all
You’re no good for me

I’ve changed my mind


17 thoughts on “Can the United States Federal Reserve raise interest-rates?

  1. hello shaun ,

    I wrote a while back that the BoE would raise interest rate on inflation – that is wage inflation only

    I suspect that the Fed would raise rates on the same grounds.

    Now we have all settled into rates being at zero and the economies are still in ground hog days I guess these “loons” will go MIRP instead of revising their economic models

    I mean did any of them forecast ZIRP for over 6 years ? what did the models say ?

    The next downturn is going to be a real interest story 😉


  2. Hi Shaun

    One thing you didn’t mention about the Q1 2015 US gdp figure was that the figures were in fact slightly flattered by some degree of inventory building (not large but some) – in addition to significant building in Q3 and Q4 of last year. It would appear that businesses cannot get rid of their inventory.

    Also they used a GDP deflator of -0.1% which means they increased the raw figure. How realistic is this? Not very would be a perfectly reasonable response.

    These two figures alone to my mind cast doubt on the Atlanta Fed’s forecasts; If businesses realise that they will have to dump inventories then the GDP number will slide, possibly below the Q1 figure, not go above it.

    There are those that think the US is already in recession.

    I believe we will get a recession before we get interest rate increases and even if we do not the debt is building up to ever more painful levels which means that, even in the “good” times it would be very difficult to increase rates. I put “good” in inverted commas because due to the debt levels and the productivity issue will we be be getting back to what everyone sees as normal anytime soon? – I don’t think so.

    • Hi Bob J

      The higher inventories issue is kind of a theme of the day as the 0.6% growth produced by Japan in Q1 was mostly caused by a build up of inventories. I was asked earlier if I thought that 3% interest-rates or QE4 was the more likely. I replied that we could easily see QE5 before 3% interest-rates.

      Troubled times indeed…..

  3. Shaun, you don’t mention Canada as a country where the central bank cut its interest rate in 2015. Of all the cuts this year I suspect that the Bank of Canada’s surprise drop of the overnight rate from 1.0% to 0.75% in January would have the biggest impact in discouraging the US Fed from raising its bank rate. Canada was (is?) the largest US trading partner and a new manufacturing plant is quite likely to go to Windsor rather than Detroit based on the exchange rate; it is unlikely to go to Jutland whatever the value of the Danish kroner.
    The Canadian dollar was worth 86.7¢ US in December (the average noon-spot rate). In April it was worth 81.1¢. Yesterday it was up to 81.9¢, however Governor Poloz gave a speech yesterday, which suggests that the loonie may be down again today. This unfavourable exchange rate movement, from American exporters’ vantage point, would have been one of the factors holding down US GDP growth in 2015Q1, and it will weigh on their growth going forward as well.

    • Hi Andrew

      You make a very good point and so far in 2015 (up to March) Canada has been the largest destination for US goods exports at US $69.35 billion. It is not the largest exporter of goods to the US as China at US $110.5 billion has been but US $74.46 billion puts it in second place. It is not far off as important as the European Union and in fact has bought more US imports. I still wish that you did not call your currency the loonie though…..

      You made me think that if one looks north one can also look south and in Q1 Mexico took US$57.15 billion of US imports and exported back some US $69.9 billion. So we should not forget the Peso nor that fact that the Central Bank of Mexico seems to be hinting at its own interest-rate cut from 3%. Should it happen it would be kind of a top and tailing for the US in 2015 would it not?

      So yes I should when looking at the US cast an eye both north and south…..

      • Thank you, Shaun. By the way, the loonie had the same noon spot rate against the US dollar today as yesterday, so perhaps my snide remark about how Governor Poloz’s speech yesterday would probably drive its value down was unfair. I don’t know anything about Mexican monetary policy but since you brought it up, I quickly verified that the Mexican central bank had lowered their bank rate from 3.5% to 3.0% at the beginning of June, less than a year ago, so that has probably discouraged the US Fed from raising its bank rate as well.

  4. Hi Shaun
    Now the Obamacare costs effect on GDP figures are diminishing; the ‘weather correction’ of Q1 numbers is as whacky as ever; the part-time jobs ,created for retirees and to keep healthcare costs of company books, depress productivity. and wage growth; fracking no longer accelerating …a better view of US performance is available. Its flat.
    The Fed is on the horns of a dilemma of its own making. Not just from 2008 but from its policies over the last 25 years at least. What value the ‘put’ now?
    Unfortunately the age old ‘solution’ to this has been to wage war in order to create a stimulus.
    We all really need some breakthrough technology that ‘breaks the mould’ , and quickly.

    • Hi JW

      Yes we do need the “something wonderful” from 2001 A Space Odyssey and as no monoliths seem to be in even the sight of the Hubble Telescope we will have to do it ourselves. Instead though we seem to get special pleading by agents of the Vampire Squid that wealthy pharmaceutical companies need a subsidy to produce new antibiotics! All rather a contrast to the 2 Aussie doctors who found a cure for stomach ulcers and were bullied to keep quiet by the same pharmaceutical companies. The military-industrial complex was not the half of it.

      ” I am thus delighted that an economist of the stature of Jim O’Neill has agreed to investigate these issues, with an eye on the incentives, regulatory systems and behavioural changes that will be required to resolve them. ”

      I can’t say that I am delighted that the Vampire Squid’s man is in charge of “incentives and regulatory systems”…..

  5. Hi Shaun,

    I have long thought like you and have commented here in the past that the CB’s are relying on Forward Guidance to stimulate the markets to get the job done for them without them having to do anything and by and large it’s worked well.

    When it won’t work well is when the markets decide to play chicken, only, as a private investor I wouldn’t play chicken with the Fed because of all the CB’s they’re the most likely to do the right thing regardless of the $ impact.

    GDP wise again, I have posted on here previously (last year) that the US wouldn’t do much in the first half but would do well in the second half whilst I’ve also said a couple of months ago China will continue to disappoint this year (although it will do a little bit in late Summer). The M1 numbers tell the story.

    I simply have to take you to task about this:

    “In April, average hourly earnings for all employees on private nonfarm payrolls rose by 3 cents to $24.87. Over the past 12 months, average hourly earnings have increased by 2.2 percent.

    Hardly racing away is it as the last quarter of 2014 saw growth of 2% per annum? If we look back to the pre credit crunch period then depending on which measure you use you would estimate it at being 3-4% per annum.”

    When you also state this “The price index for gross domestic purchases, which measures prices paid by U.S. residents, decreased 1.5 percent in the first quarter, compared with a decrease of 0.1 percent in the fourth.”

    So that would mean that the “adjusted” wage increases have been 1.6% in the first quarter yes? Whilst average US inflation in Y/E December 2014 was 1.6% this would mean real wage rises of about 0.6% or are the 2.2% annual wage rises already adjusted for inflation and are in fact real increases of 2.2%? If my 1st quarter real wage rise analysis is correct then it is very likely that following good numbers which will start appearing from July/August the Fed will edge rates up in September/October as I see inflationary pressures beginning to build (seen the US housing market recently?) and I’m sure the Fed does too.

    So, no surprises for me and I completely disagree with your suggestion of no growth/faltering growth in the second half, in fact I’m not sure I agree with any of your forward analysis today so it’s going to be a fun second half seeing which of us is right.

    • Hi Noo2

      The wage figures are nominal ones and so one can add the price falls to them to get an idea of real wage growth. Another way of putting that is that falling energy (and to some extent) food prices have made Americans better off. So far they may have spent more on imports but otherwise they have saved it. If they spend it then you will likely be right if not it will be me. Although of course things will really have to motor in the second half of 2015 in the US to make up for the ground which has been lost

      Of course the second half of the year may also be affected by the seasonality adjustment I mentioned in my reply to Forbin. If you raise seasonality in Q1 you have to subtract it from somewhere unless of course it is from the 5th quarter.

      • Frankly it looks bizarre and once more I question exactly how much “better” Western stats are than the oft criticised Far eastern ones….

        • Gross domestic purchases is the US BEA’s term for what SNA2008 calls gross domestic final expenditure. It is GDP less net exports. The GDFE deflator is certainly a useful deflator for calculating real income series. However, in my opinion, it is way too broad to be used to deflate nominal wage series. For these the US PCEPI is much more appropriate. It only shows a drop of 0.5% in 2015Q1 and a drop of 0.1% in 2014Q4.

  6. You wouldn’t bet against the fed, but maybe someday someone will make history and a lot of money breaking the Fed – just like Soros broke the BOE.

    • Come on – that’s a vampire squid bet, heads I win, tails I’m too big to fail and need a bailout on the backs of the taxpayer …..

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