15th December 2015
Abi Oladimeji, head of investment strategy at Thomas Miller Investment, explains below why it is not imperative that the US Federal Reserve hikes interest rates this week…
As the Fed meets this week, it is widely expected that they will take the long awaited decision to begin raising interest rates, following several false starts over the past few months.
However, the fundamental case for raising interest rates is weak. Many commentators point to strong headline data on the labour market as signs that the time may be right, but the devil is in the detail.
Look beyond the unemployment rate and the underlying data on the labour market should temper the enthusiasm generated by the headline numbers.
Moreover, in the absence of wage inflation, the low unemployment rate is not in itself cause for concern. Of course, the Fed may want to raise rates for reasons beyond economic fundamentals. For instance, it may see it as a way to curb speculation or to signal its belief that the economic outlook remains strong.
But the central bank needs to tread carefully. The issue is not whether the US economy can survive a small hike. What should give the Fed pause is the asymmetry of the risks – at this point in time, the threat posed by unanticipated inflation pales in comparison to the danger of stunting growth.
In the absence of rate hikes, there is a high probability that the recorded pace of economic growth over the next two quarters will undershoot expectations. Given this outlook, rate hikes at this juncture would risk amplifying the headwinds facing the US economy
To begin raising interest rates at a time when key leading economic indicators point to diminishing growth momentum raises the risk of policy errors, and may lead to a U-turn further down the road.
There are two key questions to ponder. Is the Fed likely to raise interest rates this week? Yes. But should the Fed raise interest rates this week? No!