Fed Integrity will be tested as Market doubts September rate hike

U.S. inflation in the first half of the year was probably “markedly lower” than reported, but policymakers are unlikely to set interest rates incorrectly as a result, according to an analysis published Monday by the San Francisco Federal Reserve Bank. The Fed stepped in again that year with a third round of stimulus, referred to as “QE3”.

New US single-family home sales rebounded in July and consumer confidence increased to a seven-month high in August, pointing to underlying strength in the economy that could still allow the Federal Reserve to raise interest rates this year.

Kathy A. Jones said the “odds are pretty low now” that the Fed would raise the benchmark lending rate despite previously settled predictions that such a hike would come as soon as September. The economic recoveries in both regions are much more fragile than the one in the U.S., and I strongly suspect central bankers there will be eager to counter what they will see as counter-productive strengthening in their currencies. “And the Fed was explicit saying it was that shutdown that they sort of had to wait, and it was in December that they moved”.

The consensus for a hike has already shifted once this year when economists collectively moved to September from June earlier, after data showed the U.S. economy surprisingly contracted in the January-March quarter.

But John Cochrane, an economist at the Hoover Institution, a free-market think tank at Stanford University, dismissed those concerns as overstating the power of the Fed in the global economy, and of the impact of global stock markets on U.S. monetary policy.

Monday’s remarks suggested he may have retreated somewhat from that view.

“You would be insane to raise interest rates when markets are in such turmoil”, said Martin Barnes, chief economist at BCA Research in Montreal.

If the U.S. economy continues to improve at its current pace, economists say the Fed’s interest rate will eventually top out at 3 percent.

Atlanta Fed President Dennis Lockhart, who two weeks ago was “very disposed” to begin policy tightening in September, on Monday said only that it was likely to occur “sometime this year”. This time, battles over Planned Parenthood and education could lead to another standoff between the Republicans and the White House, and Heckscher doesn’t see the Fed making a move under threat of a shutdown.

The annual policy conference in the Grand Teton National Park in Wyoming, starting onon Thursday, has traditionally been a forum for chin-stroking academic ruminations. But he said the markets “would be in better shape if they do”. Monday was proving to be a wild ride for investors across the globe, and many now believe the instability and questions about the global economy’s future should rule out a Fed rate rise for now.

Compared with the last time the Fed raised interest rates nearly a decade back, the inter-connectedness of financial markets has increased manyfold – and the recent developments in markets from FX to stocks to commodities would at the very least push for a pause. The excuse is always different, but that is what makes a market. Instead, we believe the FOMC will delay the start of the rate hike cycle beyond September as a means to offset tighter financial conditions while it evaluates the effect of recent volatility.