What Data is the Federal Reserve Looking At?
When the financial crisis hit in 2008–2009 the Federal Reserve slashed the “Federal Fund Rate” (the rate at which banks lend money to each other) from around 5.25% to 0.25% which is effectively zero.
Interest rates remained at close to zero percent for nearly seven years. As illustrated in the following chart.
The reason the Federal Reserve slashed rates was to help stimulate the economy following the financial crisis.
The cheaper money is to borrow, the more businesses and consumers will borrow money to invest and buy things, effectively giving the economy a shot in the arm.
The monetary policy implemented by the Federal Reserve over the past decade has achieved its objective as the U.S economy is running near full capacity and unemployment is at record lows.
Since the economy no longer needed this monetary stimulus, the Federal Reserve began increasing rates again starting in 2015. It did this for several reasons but two, in particular, stand out to me.
- To avoid “overstimulating” the economy which would lead to inflation
- By raising rates while the economy is doing well, the Federal Reserve gives its self wiggle room to lower rates again during the next recession
So, the federal reserve began slowing increasing interest rates starting in 2015 and then quickly increasing rates in 2018.
The Federal Reserve has been clear in the fact that future decisions on whether or not to raise rates will be “data-driven”.
So, the question remains.
What Data is the Federal Reserve Looking At?
When the Federal Reserve makes interest rate changes it takes a lot of time for those changes to ripple through the economy. So, the Federal Reserve is not making rate changes based on the current state of the economy but the future state of the economy.
The Federal Reserve’s monetary policy has two primary objectives
- Keep inflation within its target levels
- Provide economic stimulus (if needed)
Here are some of the data they might be looking at to inform future interest rate decisions.
- Despite the impressive number of new jobs added in January, wages have only increased by 3% in the past 12 months.
- Normally when unemployment falls this much, we would expect wages to rise rapidly as employers must get more competitive to attract employees.
- This usually translates into higher wages. Except this has not been the case. I wrote about two possible reasons for there here.
- Despite a hot economy, inflation only increased by 1.9% in 2018.
- The sticky wages just discussed play a large roll in that. Typically, if wages rise significantly, that means people have more disposable income which means the demand for goods and thus prices will rise.
- Sticky wages means unemployment can drop but inflation might not increase. That is causing many to question whether the Phillips Curve is broken.
If wages and inflation are not rising during record levels of unemployment, why would we think inflation is going to be rising significantly in 2019? If the Federal Reserve does not believe inflation will be a problem any time soon, that would support a decision not to increase rates.
- The trade war with China remains a concern.
- Brexit also presents trade risk that must be taken into consideration.
- China is experiencing it’s lowest level of growth since 1990.
- U.S corporate earnings have been mixed with some expectations of lower returns going forward.
- Italy is officially in a recession
- The U.S housing market has been slowing.
All these factors point to the idea that global economic growth could slow down in 2019. If the Federal Reserve believes economic growth will be less than originally forecasted that would support a decision not to increase interest rates and potentially even lower interest rates if they believe the economy needs monetary stimulus.
If the Federal Reserve does stop increasing interest rates there will be two groups of people who will win.
- People who own stocks
- People carrying debt
If you want to know how interest rates impact the stock market checkout this story
You may have noticed that after years of relentless upward movement, volatility has returned to the stock market. It…medium.com
This article is for informational and entertainment purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.