Policy
Monetary Policy
The Federal Open Market Committee in late January decided to keep the target range for the federal funds rate unchanged at 0.25 to 0.50 percent, following a 0.25 percent hike the previous month – the central bank’s first credit tightening in over nine years. Considering recent stock market turmoil, plunging oil prices and no meaningful evolution in economic conditions since the policy-making committee’s mid-December meeting, the decision was not difficult to make.
Economic data released since the Dec. 15 – 16 meeting presented mixed signals—industrial production fell, GDP rose, the jobless rate held steady, while employment hit a new high at year-end. Wage and benefits growth remained sluggish. The employment-cost index, a broad measure of worker compensation, climbed just 0.6 percent in the final three months of 2015. The core personal consumption expenditure price index, the Fed’s favored inflation gauge, rose 1.3 percent last year, well below its 2 percent inflation target.
On top of those indicators, lower oil prices and weak global economic growth may have made Fed policy makers more cautious about further tightening. A second interest rate increase in March has become unlikely as well.
Financial market turmoil might be another concern. Just after the FOMC released its meeting statement on Jan. 27, U.S. stocks tumbled. The Dow Jones Industrial Average, for example, slid about 154 points, or 0.96 percent, shortly after the statement was released at 2 p.m. that day. But higher volatility was not expected to last long. The Chicago Board Options Exchange’s Volatility Index, or VIX, a popular measure of market expectations about volatility over the next 30 days, closed at 23.11 that day, much lower than the 27.59 close a week earlier. This implies that financial markets are sensitive to economic news in the short run, but relatively low VIX readings show that market participants don’t expect volatility to continue much longer.
All in all, the recent economic data has sent markets mixed signals. But our Business-Cycle Conditions model this month shows a leading indicators diffusion index of 54, an above-average reading. More data will be needed to confirm the economy’s direction.
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Oil Policy
Too early to see full implications of ending U.S. export ban
In the September 2015 Business Conditions Monthly we argued that global events could lead U.S. lawmakers to lift a ban imposed in 1975 on exports of domestic crude oil (https://www.aier.org/bcmpolicysept2015). This has now happened. The ban was repealed in a spending bill that President Barack Obama signed on Dec. 18. Since then, several shipments of American crude have left U.S. shores.
When we wrote about the possibility that the ban might be lifted, we argued that “ending the policy would raise U.S. crude prices, stimulating investment, spurring production, and lowering pump prices.“ It is too early to see any changes in investment or production, and the low global price of oil is likely to depress production, with or without the export ban. But we can see the change in the price of U.S. domestic crude oil, which is measured by the West Texas Intermediate (WTI) benchmark. The global crude price is measured by the Brent benchmark. Since 2011, the WTI price has been below the Brent price, reflecting excess domestic supplies. But the day after the ban was lifted, the WTI price rose above the Brent price, and it remained higher through the end of January (Chart 4). However, both WTI and Brent continue to trend downward, reflecting weak global demand relative to supply. But had the export ban remained in place, the long-standing discount on U.S. crude no doubt would have continued.
One might worry that exporting crude oil could lead to higher gasoline prices down the road. That is unlikely. Gas prices are linked to the Brent benchmark, because exporting domestically refined gasoline, unlike crude oil, has always been allowed. Since the crude export ban was lifted, U.S. pump prices have fallen, following the global trend in oil prices. On Dec. 18, the average U.S. retail price of regular gas was $2.04 a gallon. By Feb. 1 it had fallen to $1.82.
The reasons for oil price declines, which lead to lower gasoline prices, range from China’s slowing economy to lifting trade sanctions on Iran. American crude being sold on the global market now can be added to this list.
