April 16th, 2015 4:30 pm
Via Jon Hilsenrath at the WSJ:
By Jon Hilsenrath
April 16, 2015 3:15 p.m. ET
A patch of soft economic data has created uncertainty inside the Federal Reserve about when to start raising short-term interest rates, reducing the probability of a move by midyear.
Recent reports showed a slowdown in U.S. hiring in March, tepid growth in consumer spending at retail stores, a big drop in industrial output and softer-than-expected home building, reinforcing a view the economy downshifted in the first quarter and didn’t have great momentum moving into the second.
Fed officials want to see continued improvement in the job market and want to be confident inflation is rising toward 2% before they raise rates from near zero. Most of them see the first-quarter growth slowdown as temporary, but they will need time to make sure a rebound is in store.
“Data available for the first quarter of this year have been notably weak,” Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, said Thursday in a speech in Palm Beach, Fla. That “is giving rise to heightened uncertainty about the track the economy is on.”
For Fed officials, the turn of events is somewhat of a recurring nightmare. Growth has continually come in short of their expectations in an expansion nearly six years old. The disappointments, in turn, have consistently forced them to recalibrate their plans.
Many officials entered this year thinking the economy was finally on a stronger growth path after several strong months in 2014 and signs that headwinds related to the financial crisis were receding. As a result, they started looking toward an initial rate increase at midyear.
At the Fed’s March meeting, they opened the door to considering a rate increase in June. But even before the recent spate of weak numbers they were divided on whether action would be warranted by then.
Mr. Lockhart’s comments are notable because he often reflects a middle ground among Fed officials when they are divided on policy questions. In February, Mr. Lockhart said he wanted to keep open the possibility of a rate increase by June. He made no mention of a June move in his comments Thursday and said “affirmative evidence” that the Fed is reaching its goal of 2% inflation isn’t likely in the very near term.
Echoing this hesitation, Boston Fed President Eric Rosengren said in a speech in London, “it remains difficult to separate the temporary and easy-to-explain from the lasting and more concerning—so in my view, incoming data would need to improve to fully satisfy the [Fed’s] two conditions for starting to raise rates.”
Some officials who appeared inclined to move by June are giving themselves wiggle room. Cleveland Fed President Loretta Mester told The Wall Street Journal in February that a midyear move was a “viable option.” In a speech Thursday, she stuck to her optimistic outlook for the economy, but conditioned a decision to act on signs that growth is “regaining momentum.”
The barrage of comments came after New York Fed President William Dudley earlier this month said weak economic data had raised the bar for rate increases by midyear.
Futures markets are already saying as much. Investors are pricing in a very low probability of a rate increase by June and market-implied probabilities for September have declined as well.
The Fed has held its benchmark short-term rate near zero since December 2008 to boost the growth during the recession and weak recovery. Most central-bank officials say they expect to start raising that rate this year, though the timing of their first move is uncertain.
The Fed’s doubts emerge as central bankers and other financial officials gather in Washington for semiannual meetings of the International Monetary Fund. Fed Chairwoman Janet Yellen will spend much of the coming days conferring with colleagues in town from overseas.
Thursday brought more disappointing economic news. The Commerce Department said groundbreakings on new homes rose a modest 2% last month, doing little to reverse February’s sharp 15% slide and a slight drop in January. Since December starts are down 14%.
Earlier in the week, the Fed reported that industrial production fell at a 1% annual rate in the first quarter, the first quarterly drop since the second quarter of 2009, thanks in part to reduced oil drilling.
Analysts at Bank of America Merrill Lynch calculate that the number of disappointing economic reports relative to positive surprises has been greater in recent months than at any point in the expansion, which began in June 2009.
Consumers’ behavior is an important puzzle for Fed officials. Job growth has been relatively strong, aside from the March slowdown. Meantime, falling gas prices are a positive jolt to pocketbooks, stock and home price gains have boosted wealth for some households, and debt burdens have been reduced.
Yet retail sales have been anemic since December. Sales excluding gasoline stations—where they are falling due to price drops—were up 4.4% in March from a year earlier, compared with a 6.7% increase in December.
“Consumer spending in the first quarter was not as strong as expected,” Mr. Lockhart said. “We did not see an expected boost to consumer spending coming from lower gasoline prices at the pump.”
American consumers are especially important to the outlook because other engines of the economy aren’t firing strongly. Most notably, a strong dollar has the potential to dent U.S. exports and oil price declines have led to retrenchment in energy sector investment. Meantime home building has been modest despite low interest rates.
“Not all sectors will contribute equally to growth,” Ms. Mester said. “Whether the drag from the trade sector will be larger or smaller than I’ve assumed is one of the risks to the forecast.”