The Fed will no doubt again leave interest rates unchanged next week, but is likely to start taking action in September. The fact that the economy is performing more or less as the Fed expects should be sufficient to prompt a change of monetary course. We demonstrate that the hurdle to be cleared in order for this step to occur is not very high.
The expected rate hike in September will probably push up US yields in particular and further strengthen the dollar. Janet Yellen’s hawkish turn After a respite during the Greek drama, market players are now turning once more to other topics, such as what the Fed will do. And there have been clear signals lately that a change of course is imminent. Federal Reserve Board chairwoman Janet Yellen did after all say at her congressional hearing on 15 July:
“We are close to where we want to be and we now think that the economy cannot only tolerate but needs higher rates”. Only disappointing data can now stop the Fed … So the Fed evidently sees itself on the brink of a first rate hike. It is unlikely to happen at the July meeting, as this will not be followed by a press conference at which the Fed could explain its moves in greater detail (see also p. 10). And the only probable obstacle to a September rate hike would be disappointing economic data in the interim.
If, however, the economy proceeds more or less in line with the FOMC’s updated June projections (see table 1), interest rates are then likely to be raised in September. … and this is unlikely Data obstacles to a rate move in September are minimal, since in June the Fed envisaged only moderate growth for the coming months; an unemployment rate at the June level and only marginally higher inflation: Growth: moderate Q2 pace no surprise We expect second-quarter US growth to come in at 2.3% (see p. 9), which can at best be described as moderate, taken against the backdrop of the virtual stagnation during the first quarter caused by one-off factors.
Yet the data due out next week is unlikely to take the Fed by surprise. The Atlanta Fed’s “GDP Now Tracker,” for example, which estimates GDP growth on the basis of current economic indicators, has been moving between 2% and 2.5% for some time now. The chances of growth picking up in the second half of 2015 are good, too. Both first-quarter and no doubt also second-quarter growth were depressed by half a percentage point (annualised rate) as a result of the drastic reduction by oil companies of drilling activity on account of low oil prices.
With the number of active drilling rigs now apparently stabilising, this handicap should disappear in the second half of the year, so that annualized quarterly growth rates of around 2¾% which are required for the Fed’s June growth projection to be realised (1.9% growth year on year in the final quarter of 2015) seem perfectly realistic.
. The unemployment rate is the average figure for Q4. (**) Commerzbank forecast Sources: Fed, Commerzbank Research 1 The headline inflation rate is also a part of the FOMC projections. In the short to medium term, though, price trends are better reflected by the core inflation rate, so this is what we concentrate on.
At first glance, this element of the Fed’s projection is the easiest to achieve. The unemployment rate did after all drop to 5.3% already in June, which is where the Fed was expecting it to be in the fourth quarter. It should continue to decline in the coming months even if the rise in employment falls short of the rather rapid first-half pace averaging 200,000 per month. The US Department of Labor has estimated that the labour force – the pool of available labour – is increasing by at most 80,000 per month.
This means that only a steep – and highly unlikely – rise in the participation rate would prevent an even lower unemployment rate. Janet Yellen has stressed repeatedly, however, that when assessing the situation on the labour market the Fed considers not just the unemployment rate but other factors as well. These paint a slightly less favourable picture, but confirm the strong labour-market recovery which should gather strength over the next few months:
• The number of job openings is at its highest since 2001, at the peak of the new economy boom (see chart 1). • Workers are now also feeling more confident about voluntarily terminating their employment. The quit rate is rising very slowly, though (see chart 2), and is still below the pre-recession level of 2007/2009. • The same is true of the rate of new hires (see chart 2). However, the combination of a very large number of job vacancies and restrained job market turnover indicates that employers are not able to fill the jobs available quickly. • The last four years have seen a sharp dip in the number of long-term unemployed (see chart 3, p.4). In relation to the labour force, at 1.4%, it is still roughly as high as during the last two cyclical highs.
At that time, though, similar long-term unemployment rates did not prevent the Fed from raising interest rates. In February 1994 – at the time of the first rate hike in that cycle – it was also 1.4%. In June 2004 (also lift-off point) it stood at 1.3%. • Part-time work for economic reasons (those wanting to work full time but unable to for lack of corresponding jobs) is admittedly still well above the pre-crisis level (see chart 4, p.4). A longer-term comparison shows, though, that the level was also unusually low between 1997 and 2007.
Inflation: current price pressure is sufficient If, as the Fed expects, core inflation – measured by the consumer spending deflator excluding energy and food – is to rise to 1.3% to 1.4% by the fourth quarter (1.2% in May), prices would have to rise over the rest of the year by no more than an average of 0.11% per month. This would be less than in each of the four months through May, and for June, on the basis of consumer prices, we already expect an increase of 0.14%.
