Imagine being stuck in a blizzard. You look out your window and can see the snow piling up outside, yet the meteorologist on your TV is forecasting continuing sunshine and near tropical weather.
That level of disconnect is similar to that shown by some members of the Federal Reserve Board, who are preparing for liftoff, even as the economy implodes like a SpaceX rocket. The difference, though, is that the SpaceX failure was an unmanned flight; when the Fed acts, we’re all on board, like it or not.
We recently reported that a couple of members of the Federal Open Market Committee had spoken publicly in favor of a rate hike. But this past week, they were no longer the outliers, as even Fed Chair Janet Yellen joined in during a speech before the Economic Club of Washington.
USA Today reported, “Federal Reserve Chair Janet Yellen signaled Wednesday that the Fed is all but certain to raise interest rates this month for the first time in nearly a decade, saying that gains in the economy and labor market have met the central bank’s goals.”
If you read on, though, that’s not quite what she said. Given that inflation is nowhere near the Fed’s 2% goal, she couldn’t say that the central bank’s goals have been met.
Instead, she said, “I currently judge that U.S. economic growth is likely to be sufficient over the next year or two to result in further improvement in the labor market.” Those gains, combined with market inflation expectations, “serve to bolster my confidence in the return of inflation to 2%” as the effects of low energy and import prices fade.
Now why would the effects of low energy and import prices fade? Energy prices have continued to drop and prices are expected to stay low. Saudi Arabia, which caused the decline a year ago, is unlikely to raise prices, as doing so would help rivals Russia and Iran – and it might even revive the fracking industry in the U.S.
As for the effects of import prices fading, the dollar has been strengthening and will become even stronger as interest rates increase and as the European Central Bank (ECB) continues its stimulus efforts.
Granted, “ECB president Mario Draghi didn’t deliver on the market’s hopes for a steep interest rate cut,” according to USA Today, “and the failure to give the market the amount of stimulus it hoped for caused the euro to spike against the dollar, a development that hinders the ECB’s ability to jump-start growth and boost dangerously low inflation.”
But that spike is temporary. If the ECB is practicing any level of stimulus at a time when the Fed is raising rates, the dollar will strengthen again. If Draghi responds to investor disappointment and adds further stimulus, import prices will continue to fall. Deflation, not 2% inflation, is the likely outcome.
What’s So Compelling?
Even before Yellen’s speech boosted the probability of a rate increase this month to 75%, Federal Reserve Bank of Atlanta President Dennis Lockhart was pressing the case for a rate increase, saying, “absent information that drastically changes the economic picture and outlook, I feel the case for liftoff is compelling.” He also argued that the economy is growing and that inflation is depressed due to “temporary factors.”
We’re not sure how he defines “temporary” and if the case is compelling, we’re not sure what case he’s talking about. His case for economic growth seems pretty weak when you consider that his endorsement of a rate hike came the day after the Atlanta Fed cut its fourth quarter estimate for growth in gross domestic product to just 1.4%. Less than two weeks earlier, the forecast called for 2.2% growth, and then the forecast was reduced to 1.8% less than a week later.
A rate increase now, Lockhart said, would be “a vote of confidence” in the economy, but, given the forecast by his staff, is confidence warranted?
Meanwhile, the Institute for Supply Management reported that economic activity in the manufacturing sector contracted in November for the first time in 36 months. The Purchasing Managers’ Index (PMI®) fell to 48.6% (any number under 50% represents a contraction). New orders, production and inventories are all contracting, while supplier deliveries are slowing.
So where’s the compelling case for a strong economy?
There hasn’t been this much lying about the state of the U.S. economy since the last presidential election.