Share:

Additional assets 40848

chart4
Share:
Share:

Additional assets 40849

chart5
Share:
– July 15, 2016

Monetary
The Brexit vote, weaker labor market conditions, and a stronger dollar make it unlikely that the Fed will raise interest rates again soon.
Ever since the Federal Reserve raised interest rates in December, the financial markets have eyed the possibility of another interest rate increase. But in light of the latest developments, both global and domestic, this now looks increasingly unlikely.

The Federal Open Market Committee, the policy-making arm of the Fed, kept interest rates unchanged when it met on June 14–15, and it lowered its outlook for the path of rate increases for the rest of the year. The number of FOMC participants who favored two or more rate increases in 2016 fell to 11 from 16, while the number favoring no more than one rate increase rose to six from one.

In June no one on the FOMC argued for keeping interest rates unchanged throughout 2016. This, however, may change in light of recent news and data. The extremely disappointing employment report in May, showed only 38,000 jobs added by the U.S. economy in May, and the news of the Brexit, which roiled financial markets and pushed the foreign exchange value of the dollar higher, make it unlikely that the Fed would want to raise rates soon.

In the days following the Brexit referendum, the U.S. dollar appreciated against the British pound by about 13 percent and against the euro by about 2.3 percent. An appreciating dollar is good news for U.S. tourists to the U.K., but it tends to hurt U.S. exporters. Chart 4 shows that, over the past two decades, periods when the dollar appreciated coincided with a slowdown in export growth or an outright decline in U.S. exports.

U.S. exports were already struggling because the dollar has been rising against other currencies since early 2014. The additional spurt in the dollar’s appreciation following the Brexit vote pressures exports even more. This, in turn, will likely restrain output growth in the U.S., which has not been spectacular to begin with. The latest GDP estimate for the first quarter of 2016 shows that U.S. output grew only 1.1 percent (annual rate), the weakest growth in a year.

In addition, labor market conditions, which had been a positive sign in the U.S. economy, have started to show some weakness. The extremely slow job growth in May was partially offset by faster growth in June, but a broader indicator—the Labor Market Conditions Index from the Federal Reserve Board—has been stuck in negative territory since January.

The Labor Market Conditions Index captures the common movement from 19 labor market indicators, such as the unemployment rate, labor force participation rate, average hourly earnings, and others. As such, the index is a more comprehensive reflection of the state of the labor market than any individual indicator. Over the past three decades all economic downturns were preceded by persistent negative readings of the index (see Chart 5), but in a few cases negative readings were not followed by a broader downturn. Nevertheless, the negative readings of the index for the past few months are a cause for concern.

In such circumstances, raising interest rates, also known as a tightening monetary policy, is not likely to be an attractive option. Higher interest rates would further strengthen the U.S. dollar and could potentially raise the cost of capital. This in turn would depress exports and further restrain economic growth. The Fed would almost certainly not want to do this in July and maybe not even later in the year. 

Next/Previous Section:
1.Overview
2. Economy
3. Inflation
4. Policy
5. Investing
6. Pulling It All Together/Appendix

 

Related Articles –

No items found