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Why the Federal Reserve May Not Raise Interest Rates

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February 9, 2015
Why the Federal Reserve May Not Raise Interest Rates

Is a Federal Reserve interest rate hike later this year a foregone conclusion? In and around the financial markets, it’s difficult to find anyone who doesn’t subscribe to this conventional wisdom.

It’s true the Fed aims to wean the U.S. off the quantitative easing “steroids” that helped pull the country back from the brink of financial catastrophe. In global economic terms, the U.S. is largely outperforming Europe and Japan amid accelerating job growth and consumer spending.

For months, Janet Yellen and other Fed leaders have been carefully articulating a road map to the inevitable tightening cycle. Following the Fed’s policy-setting meeting January 28, the central bank said it “can be patient in beginning to normalize the stance of monetary policy.” Many observers interpreted that to mean the central bank would not raise its benchmark fed funds rate any earlier than June (the rate has been held to a target range of zero to 0.25% since late 2008).

Still, June is a ways off. A lot can happen in the coming months, and the world has a knack for throwing out surprises. With that in mind, let’s run down four reasons the Fed may not raise rates this year (or at least not before late summer).

  1. Low Inflation. Once an economic demon, inflation in the U.S. has been tame for years. That’s good for many reasons, but if inflation is too low, that means there’s little traction for businesses to increase prices or for economic growth (just ask Europe). Fed officials have said they will lean heavily on economic data for making policy decisions. This raises the question of whether cheaper oil, if sustained, buys the Fed more time before it pulls the rate-hike trigger. By the same token, if low inflation is sustained largely because of cheaper energy, the Fed may look past that and move forward with a tightening phase.
  2. Weak Wage Growth. Inflation can bubble up quickly in wages. But wage gains have averaged 2% or slightly less per year since 2010, just two-thirds the usual pace during economic recoveries. Payroll growth is steadily improving and companies are posting more job openings. Will meaningful wage growth follow?
  3. Europe’s Malaise. Yellen, the Fed Chair, has stressed the relative insulation the U.S. economy has against Europe’s sluggish economy, deflation threats, and political scuffles. But just as the ripples from oil markets travel around the globe, so do the problems of financial system anchors and giant trading partners like Europe (and China). The divide between U.S. policy and that elsewhere (which, by the way, has driven up the U.S. dollar) may give the Fed pause.
  4. When Doves Cry. Chicago Fed President Charles Evans, a member of the central bank’s policy-setting committee, has stated a preference to leave the funds rate untouched until 2016, citing low inflation. Another policy-setter, the Atlanta Fed’s Dennis Lockhart, stressed the virtue of patience when it comes to lifting rates. These policy “doves” appear to share a similar philosophy with Yellen, which begs the bigger question: do they have enough of a voice to out-squawk the inflation-busting “hawks,” or at least slow the onset of tighter policy?
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