August 25, 2015    3 minute read

Will the Fed Pull the Trigger?

   August 25, 2015    3 minute read

Will the Fed Pull the Trigger?

Will the Fed raise rates in September for the first time since 2006? The interest rates will probably rise by the end of the year but the Fed has been careful to avoid any commitments. However, looking at current market conditions suggests that rising interest in the near future would create a serious threat on all three of the Fed’s objectives – price stability, full employment, and financial stability.

The unemployment rate measures the number of people actively looking for a job as a percentage of the labour force. The Fed can comfortably say it has met its full employment objective with the unemployment rate below 7 percent since December 2013, and at 5.3 percent for the last two months. This leaves the Fed looking for ‘some’ confirmation in the labour market regarding financial stability.

us unemployment

The Fed has put its price stability objective into practice by adopting a 2 percent inflation target. While unemployment looks promising price stability on the over hand is worrying as more than half of the components of consumer price index have declined in the past six months.The biggest risk at the moment is that inflation will be lower than the target, and the tightening of the monetary policy could worsen the situation. Core CPI inflation, which excludes volatile food and energy prices and housing, is less than 1 percent. If China and other emerging market currencies depreciate further, US inflation could become more dispirited.

Raising interest rates could have a negative impact on employment levels, as higher interest rates will make holding onto cash more attractive as opposed to investing it. The tightening of monetary policy will also increase the value of the dollar, leading to a fall in the trade balance as US producers are less competitive putting pressure on the US economy.

If there is so much risk in raising interest rate in the near future, then why is there so much pressure on the fact  that a rate increase is necessary? The pressure is from the belief that the economy is hugely normalised from the six years of recovery, and thus the stimulus of zero interest rate should be removed.

The newly developed market conditions would require new policies. Therefore, there are steps to be taken such as promoting public and private investment to raise the level of real interest rates that are consistent with the full employment. Without a miracle of inflation accelerating sharply or an extreme market confidence breakout, there may be no case for the Fed to tighten its monetary policy through increase interest rates in the very short term.

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