International economic uncertainty and a “surprisingly weak” May employment report helped persuade the Federal Reserve to hold back on plans to raise interest rates, according to notes of the central bank’s June meeting released Wednesday.
Although the meeting took place before Britain voted to leave the European Union, the Federal Reserve notes said that most of the participants in the meeting of the central bank’s open market committee “noted that the upcoming British referendum on membership in the European Union could generate financial market turbulence that could adversely affect domestic economic performance.”
The Fed minutes also said “it would be prudent to wait for the outcome of the upcoming referendum . . . in order to assess the consequences of the vote for global financial market conditions and the U.S. economic outlook.”
They said that foreign economies “appeared to be subdued, that global inflation and interest rates remained very low by historical standards, and that recurring bouts of global financial market instability remained a risk.”
At the same time, the Fed said that the U.S. economy continued to show signs of greater strength. It said that some members of the rate-setting committee pointed to an increase in core inflation (excluding oil and food) and a “firming in wages.” The May employment figures were seen as a possible aberration. The notes said that most Fed governors thought that “in the absence of significant economic or financial shocks, raising the target range” for interest rates “would be appropriate” if domestic trends continued.
“The Fed will probably keep rates lower for longer than otherwise would have been the case,” Steve H. Hanke, professor of applied economics at Johns Hopkins University, said regarding the impact of the Brexit vote.
Chris Rupkey, chief financial economist at the Bank of Tokyo, said that a strong jobs report this Friday could alter market sentiment and encourage the Fed to raise rates in September. “Stay tuned,” Rupkey said. “This Friday’s jobs report is going to be a big one. A rebound in jobs could really put a Fed rate hike back on the table this year in a hurry.”
The Fed notes came out as the British decision to exit the European Union continued to roil world markets Wednesday. The British pound sank to the lowest levels in more than three decades, and interest rates for U.S., British and Japanese government bonds hovered around their lowest levels ever as investors flocked to safe securities.
The yield on Japan’s 20-year government bond fell below zero for the first time, as nearly $12 trillion of government bonds have yields of zero or below zero. Bond yields sent signals that risk-averse investors are seeking safe havens while bankers are unwilling or unable to lend more money because of legal capital reserve requirements.
U.S. stock markets, however, were steady Wednesday, bolstered by new data that showed that the U.S. services sector grew at the fastest pace in seven months and later by the Fed minutes. Shares fell in Europe.
Meanwhile, the European Union faced new threats even as it debated how to ease Britain out of the group. Germany was pressing for sanctions against Spain and Portugal for failing to implement austerity measures instead of letting their budget deficits rise beyond E.U. guidelines. And Italy’s prime minister Matteo Renzi is weighing whether to defy the E.U. and inject billions of euros into the country’s ailing banks.
If the E.U. imposes tight restrictions over its remaining members, political turmoil could spread well beyond London. Renzi, whose party recently suffered municipal election setbacks, faces a constitutional referendum in October.
“If Brexit leads to the meltdown of the Italian banks or to ‘Quitaly,’ then Europe could fall into a recession and drag down the global economy,” Edward Yardeni, president and chief investment strategist at Yardeni Research, said in a note to clients. “ ‘Quitaly’ could be the next crack in the E.U.’s foundation.”
World Bank data showed that the ratio of nonperforming loans to total loans at Italian banks grew to 17.3 percent during 2014, up from 5.8 percent during 2007. (By comparison, the ratio of bank nonperforming loans in the United States peaked at 5 percent in 2009 during the darkest days of the financial crisis.)
Notes of the Federal Reserve meeting that took place in June — before the Brexit vote — were expected to show that the central bank was leaning against raising interest rates anytime soon, not only because of the tepid recovery in the United States but also because of concerns about turmoil abroad.
“The Fed was justifiably spooked by the prospects for a Brexit and the potential fallout against the backdrop of what could be a weakening economy in the U.S.,” said Diane Swonk, head of DS Economics, a consultancy. “They knew a vote to Brexit could unleash a isolationist genie from its bottle. There is a real push for economic disintegration, which threatens growth in a global scale.”
Yardeni said in his note to clients that negative official interest rates at the European Central Bank and the Bank of Japan “are major contributors to the race to zero and below in bond yields.”
Hanke said that bond yields have tumbled because central banks, through their quantitative easing programs, have purchased government bonds and the safest corporate bonds. As a result, investors seeking safe investments must chase a relatively small amount of securities.
“If you look at balance sheets of central banks, a lot of safe assets have been gobbled up by the central banks,” he said. As a result, he said, “the supply of safe assets is pretty limited” while demand for safe assets is high.