After FOMC’s Latest Pause, Two Key Questions on Rates

With growth likely to be slow to rebound and oil contributing to firm inflation, look for the Fed to stay on the fence until December.

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At its otherwise uneventful April meeting, the Federal Open Market Committee appeared to pause its rush to normalize interest rates. With growth during the first quarter of 2015 even more anemic than expected, the group downgraded its outlook on the U.S. economy.

This comes as no surprise. Several Fed speakers had already softened their tone around rate normalization in the weeks leading up to the meeting as signs emerged of the U.S. economy’s stumbling. Before the group’s next meeting, in mid-June, the FOMC will have the benefit of several rounds of new economic data. Here are a few questions that the FOMC will be facing over the next several weeks.

What does the first-quarter slowdown mean for employment and job growth?

Employers sharply slowed their hiring in March as nonfarm payrolls rose by just 126,000, less than half the pace for all of 2014. For the first three months of 2015, the economy added an average of just under 200,000 jobs a month — the weakest pace in nearly a year.

Many economists are expecting 2015 to be a reprise of 2014, when economic growth contracted in the first quarter before rebounding sharply in the second and third. During the rebound last year, employment accelerated sharply. I expect better growth ahead in 2015 as well, but it is not clear what will drive it. Hence, any rally will likely not be as robust as the one seen last year.

First, a still strong dollar has hurt exports considerably. The widening trade gap has detracted from economic output in four of the past five quarters. Second, there has been a sharp slowdown in investment. We expected a steep drop — 23 percent! — in investment by mining and energy companies. More worrisome, however, was that broader-based investment in software, research and development and other things such as equipment actually showed declines in excess of 3 percent as well. Lastly, consumers are just not spending much of the windfall they have received from sustained low energy prices. Consumer spending grew only a modest 1.9 percent in the first quarter — less than half that of fourth-quarter 2014.

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Is the inflation free fall over?

The personal consumption expenditures price index, the Fed’s preferred measure of core inflation, may be near the end of its steady decline. In February core PCE halted its descent, ticking up slightly to a still modest 1.4 percent. Indeed, inflation has sustained an impressive streak of undershooting the FOMC’s 2 percent objective for 34 straight months.

Stabilization of oil prices should support firming inflation. More important, any base effects from the sharp drop-off in oil prices that started last July are likely to result in higher inflation by autumn. Let me explain. Current annual measures of inflation are biased sharply downward by comparing present oil prices of about $55 per barrel with the $100 per barrel level of last spring. Come fall 2015, the gap between oil prices in the first half of 2014 and the first half of 2015 will likely narrow and so will its distortive effect. This trend alone should account for some tangible increase in annual inflation measures.

What these factors mean for Fed policy:

I do not expect any policy action before December. With legitimate concerns about both employment and inflation, look for the FOMC to be extremely patient in moving to normalize rates — even in the face of a strengthening economy and inflation moving in an upward trajectory. Given the uneven flow of data over the past few years, do not expect any policy action until the data show a fairly established pattern of recovery in job numbers and price growth.

Shehriyar Antia is the founder and chief market strategist at Macro Insight Group, an investment strategy firm based in New York. Prior to founding MIG, he worked on quantitative easing programs and monetary policy as a senior market analyst at the Federal Reserve Bank of New York.

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