Falling inflation and a spiking dollar won’t be enough to dissuade the Federal Reserve this week from making the final preparations to raise interest rates for the first time since 2008.
The Fed’s monetary policy committee will meet in Washington on Tuesday and Wednesday. Investors expect that when the meeting is over, the central bank’s announcement will drop its previous promise to be “patient” in waiting to raise short-term interest rates and say instead that the move could come at any subsequent meeting.
“I’d be very surprised if ‘patient’ survived this meeting,” said Paul Mortimer-Lee, global head of market economics for BNP Paribas.
It’s been a long time since the Fed targeted rates above zero. It was in the teeth of the financial crisis in December 2008 that the Fed cut short-term interest rates all the way to zero in an effort to stimulate the economy. Unable to lower interest rates any further, the central bank then turned to the unconventional tools of massive bond-buying programs and promising to keep rates lower for longer.
A half-decade later, the outlook for jobs is nearly bright enough for the Fed to consider moving toward raising rates from zero, even though inflation is below the Fed’s 2 percent target and falling, and a rapidly strengthening dollar threatens to slow exports.
At 5.5 percent in January, according to the Labor Department, the unemployment rate is within the range of what Fed officials project is consistent with an economy at full health.
With unemployment nearly back to normal, Chairwoman Janet Yellen and other officials are set to pull away from the promise to be “patient” in raising rates, even though inflation and the dollar are, at the moment, moving the wrong way.
The dollar has risen more than 10 percent against the euro this year alone. Last spring, the euro was worth $1.40, but the two currencies are near parity this week.
The strength of the dollar is a “major headache” for U.S. manufacturers, said Chad Moutray, chief economist for the National Association of Manufacturers.
Two-thirds of U.S. companies for which more than a quarter of sales are overseas expect business to slow, and a quarter say they have cut plans to expand, according to a survey conducted by Duke University and CFO Magazine last week.
Nevertheless, Moutray said, manufacturers continue to “be upbeat” overall. “My view is that the Fed is going to continue to move on automatic pilot,” he said, dropping the “patient” language this week and raising rates as soon as June or July.
Investors currently see the Fed raising rates in September or December, bond market prices indicate.
Yellen set expectations for Wednesday’s announcement in congressional testimony in February, when she said that before raising rates, the Fed would drop its promise to be patient. Then, afterward, a rate hike “could be warranted at any meeting” as long as they were confident inflation was rising toward the 2 percent goal, she told lawmakers.
A main reason that Fed officials won’t be daunted by the strength of the dollar is that they attribute it to the success of the U.S. economy and their own quick reaction to the financial crisis under the leadership of Yellen and former Chairman Ben Bernanke.
“The relative strength of the U.S. economy compared to that of many of our trading partners has contributed to a more than 10 percent appreciation in the broad value of the dollar over the past year and has meant a slowdown in U.S. export growth,” Federal Reserve Bank of Cleveland President Loretta Mester said in a speech last week.
“The Fed was relatively quick to responding to [the recession] and now we’re further along in the recovery than other central banks,” said Thomas Simons, money market economist at the bank Jefferies, noting that the European Central Bank is set to engage in a $1.2 trillion bond-buying program over the next year, a dynamic that should keep the dollar strong. “If you’re an exporter, I wouldn’t be looking for the Fed to really bail you out.”
Nevertheless, Yellen and company are likely to note the appreciation of the dollar to prevent further fallout for exporters, said Mortimer-Lee.
“What she will say is: This is one of many things we’ll take into account in timing the liftoff” for rates, Mortimer-Lee said. She’ll signal “an orange light, an amber light to the market” to prevent investors from selling off the euro.
At January’s meeting, a few Fed participants did raise concerns about the strength of the dollar, minutes from the meeting show. The monetary policy announcement from the meeting also noted for the first time that the Fed would consider “readings on … international developments” in deciding to raise rates.
The biggest risk posed by the dollar, Chicago Fed President Charles Evans said at a Rotary event in March, might be that it “presents another disinflationary pressure through its influence on lowering import prices.”
If that lower pricing of imports pushes down the underlying trend for inflation, making it even longer until the rate hits the 2 percent target, it could be “problematic,” Evans said.
Inflation was at negative 0.1 percent in January, according to the Consumer Price Index calculated by the Bureau of Labor Statistics. Core inflation, a less volatile measure of price changes that strips out energy and food prices, was closer to the Fed’s target, at 1.6 percent.
