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COLUMN-Fed to move post big vote, and I don't mean Brexit: James Saft
June 7, 2016 / 4:05 AM / a year ago

COLUMN-Fed to move post big vote, and I don't mean Brexit: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

June 7 (Reuters) - Americans are likely to know both who their new president is and how their Thanksgiving turkey tastes before they get an interest rate increase.

A combination of less-than-reassuring data and political risk at home and abroad will stay the Federal Reserve’s hand, forcing it to wait far longer than it had planned and advertised before adding a single 25-basis-point rate increase to a tightening campaign it began last December.

Fed Chair Janet Yellen fully earned her scouting badge for central banking speech-making on Monday, managing to be vague, reassuring and noncommittal in more or less equal measure.

It was perhaps what she didn’t say which was most telling, ratcheting down her rhetoric about the timing of any increase in rates.

“Yellen expresses optimism throughout the speech but she doesn’t repeat her guidance from less than two weeks ago that a rate hike would be forthcoming ‘in coming months’,” Steve Englander, currency strategist at Citigroup, wrote in a note to clients.

“There is no timetable and the pluses are very vague. Unless the sky is falling in there is no way that she can express pessimism - would be self-defeating - so you take it as a given that she will sound optimistic on hitting targets in long term. The vagueness on the timing of hikes is what is striking.”

Yellen was of course speaking days after U.S. employment data showed which she termed “concerning” and which showed a sharp reduction in new jobs created in May, taking the three-month average of payroll gains to 107,000, about half where it was as recently as February.

Yellen did a nice job sketching out the unknowns, including slowing Chinese growth and the fact that inflation expectations are slipping further away from the 2 percent the Federal Reserve is supposed to achieve as its target rate of price increases.

The upcoming June 23 British vote on continued membership in the European Union is also a concern, though it looks that the Fed has good reasons at home to wait.

Yet for all the optimism Yellen laced through the speech, made in Philadelphia, the underlying details of the employment report look quite poor, though there is a good possibility that the data will reverse course over the remainder of the year.

A PATTERN

David Rosenberg, chief economist at Gluskin, Sheff Research, notes the decline in jobs in goods-producing sectors, which are now shrinking at a 1.2 percent annual rate, which he says is similar to six other such falls over the past 50 years.

“Each one of these periods presaged a recession just a few months later - the average being five months,” Rosenberg wrote in a note to clients.

None of that is foreordained, but clearly the Fed would need to see good evidence, in the form of better employment data, before it goes ahead and hikes.

A look at the financial markets shows traders attach only about a one-in-four chance of a hike by July, and still less than a 50 percent chance by the end of the Fed’s September rate-setting meeting. It is only in November, just before the presidential election, that the implied probabilities rise to 51 percent.

It is possible that the Fed will interject itself into what is likely to be a fraught national conversation by hiking six days before the vote but it would seem wise that if they wait that long they would wait until December.

The more interesting, if less likely, question is what the Fed would do if the data continues to be poor and what is now a historically long-lived economic expansion looks to be coming to an end.

The alternatives in that scenario are all less palatable than the wait-and-see gambit which the Fed can deploy now.

With rates at only a range between 25 and 50 basis points there is not much room to cut. As for negative interest rates, the evidence elsewhere shows that they work poorly and cause considerable problems, not least making the entire banking system, which depends on making money from the gap between short- and long-term rates, a suspect enterprise.

That’s before we get to the politics, which given the “tax on savers” angle are not good. More quantitative easing might help to keep asset prices high but buying things to encourage investment and spending has not been a complete success thus far.

Yellen herself perhaps said it best when asked, at the end of her Philadelphia appearance, about the potential threat to the U.S. and global economy from a Donald Trump presidency.

“I’ve got nothing for you on that,” Yellen said. “We’re very focused on doing our jobs and we’ll just see what happens.”

Probably true on any number of levels. (At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft) (Editing by James Dalgleish)

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