An unsteady hand at the Fed

1. Desmond Lachman

One has to be struck by the way Janet Yellen’s Federal Reserve Open Market Committee (FOMC) oscillates from meeting to meeting.
At its mid-September meeting, the FOMC signaled that it was in no particular rush to start raising interest rates since it was concerned that “recent global economic and financial developments may restrain economic activity somewhat and put downward pressure on inflation.”

Federal Reserve Chair Janet Yellen takes questions during a news conference following the Federal Open Market Committee meeting in Washington  REUTERS/Jonathan Ernst .

Six weeks later, the FOMC now has dropped its concern about the global economy, thereby reopening the door for a US interest rate hike by year-end.
The FOMC’s apparent unconcern now about how the global economy might impact that of the United States sits oddly with recent assessments of the global economic outlook by both the International Monetary Fund and the Organization for Economic Development. Since the FOMC’s September meeting, both of those institutions not only downgraded their global economic forecasts for 2015 and 2016 to the weakest level since 2009.  They also went out of their way to indicate that there was considerable downside risk to their forecasts.



The FOMC’s lack of concern also sits oddly with the economic troubles besetting major parts of the global economy. The Chinese economy still shows every sign of slowing as it starts transitioning to a more sustainable economic growth model and confronts a credit bubble. Meanwhile the major emerging market economies — which together with China account for more than 35% of the global economy — are close to crisis levels as international commodity prices remain highly depressed and as capital flows out of these countries at levels not seen since the Asian financial crisis in the late 1990s.
It would also seem that the Fed is turning a blind eye to the very real prospect that a further strengthening of the US dollar could constitute a significant headwind to the US economic recovery and exert downward pressure on US inflation. Over the past year, the US dollar has already appreciated by around 15%. Now it appears that both the European Central Bank and the Bank of Japan might very well step up their quantitative easing programs in response to disappointing domestic economic growth performance. Were they to do so, one must expect a further strengthening of the US dollar.
Hopefully the FOMC knows something about the global economy that lesser mortals do not. If the FOMC rushes into raising interest rates by year-end and the global economy then turns out to be very much weaker than anticipated, the FOMC could further damage its already shaky credibility.