The Federal Reserve had expected to begin withdrawing its support for the nation’s economic recovery this year, but mounting evidence of a global slowdown could extend the era of easy money.
Fed officials have signaled for months that they are getting closer to raising the central bank’s target interest rate for the first time in nearly a decade. Many investors had anticipated the milestone would come when policymakers meet in September.
But that timeline is now unlikely. Traders have slashed the odds of a rate increase next month. And a growing list of prominent economists say the central bank is not ready to let the American recovery stand on its own.
“When our growth has been as volatile as it has been, when the stock market has been as volatile as it has been . . . [raising rates now] would be undertaking undue risk,” Nobel Prize-winning economist Joseph Stiglitz said in an interview Tuesday.
The ending of the Fed’s stimulus has the potential to roil financial markets already bruised by the slowdown in China. Meanwhile, a spike in inflation, stemming from the central bank’s ultra-low interest rate, is a distant threat.
The Fed is not the only central bank under pressure. Policymakers around the world are confronting increasingly vocal calls to do more — not less — in the face of mounting fears of a global economic slowdown. China cut a key interest rate Tuesday for the fifth time in nine months and reduced the amount of reserves that banks are required to hold, moves intended to pump more money into its economy. The European Central Bank may be forced to increase its massive stimulus efforts, analysts say.
Top Fed officials will gather later this week in the foothills of the Grand Tetons with the world’s economic elite for an annual symposium hosted by the Kansas City Fed. In a break with long-standing tradition, Fed Chair Janet L. Yellen will not be attending. But investors are hoping her second-in-command, Stanley Fischer, will signal which way the central bank is leaning.
“I think the Fed doesn’t care that much about the [market] volatility, but they would care about the direction,” said Maury Harris, chief U.S. economist at UBS. “If you were consistently headed down, that would be bothersome to the Fed as a negative economic signal.”
The Fed slashed its benchmark interest rate to zero in 2008, an aggressive and unprecedented response to the financial crisis. It has kept it there ever since in hopes of fostering a robust recovery. Higher interest rates spur saving and rein in economic activity, while low rates help encourage consumers to spend and businesses to invest.
But it has been seven years since the darkest days of the recession. The country is clocking solid, though not spectacular, growth. Hiring is robust, and the unemployment rate is closing in on what many analysts believe is its lowest sustainable level. The economy is no longer in crisis mode — yet the Fed’s target is still at zero.
That was supposed to change this year. Data released over the summer showed Fed officials generally anticipated hiking rates twice. Earlier this week, Atlanta Fed President Dennis Lockhart reiterated his expectation that “liftoff” will occur this year.
But the central bank has been careful to provide plenty of caveats to its forecast. The timing and pace of the Fed’s decisions ultimately depend on its outlook for the economy. If the recovery is stronger than expected, the Fed could move more quickly. And if it is weaker, it could respond by waiting.
The question is whether the wild swings in global markets over the past few days reflect more fundamental problems in China’s economy that will reverberate back home. Goldman Sachs estimates that financial conditions are at the tightest in five years and are shaving about half a percentage point from U.S. growth. In its worst-case scenario, the global turmoil could reduce economic growth by more than twice that amount.
In addition, falling oil prices and a stronger dollar are holding back inflation, which has been running persistently below the Fed’s target of 2 percent. Wage growth, another indication of inflation, remains stagnant.
“We believe the Federal Reserve is unlikely to begin a hiking cycle in this environment,” Michael Gapen, chief U.S. economist at Barclays, wrote in a research note this week. He now predicts the central bank will not raise rates until March.
The Fed has tried, somewhat futilely, to deflect attention away from the timing of the first rate increase. It has assured investors that subsequent increases will be gradual and will probably remain low by historical standards. But delaying the first move could wind up amplifying its impact.
“The more that time passes, the more you get boxed in to this first move being the end of the era,” said a former Fed official, speaking on the condition of anonymity to discuss sensitive Fed decisions.
But John Cochrane, an economist at the Hoover Institution, a free-market think tank at Stanford University, dismissed those concerns as overstating the power of the Fed in the global economy, and of the impact of global stock markets on U.S. monetary policy.
“The link between Fed policy and the Chinese stock market is awfully long,” Cochrane said. “Next thing you know they’ll be blamed for global warming.”