The Fed has indicated that it leans toward caution in beginning to raise interest rates, as it remains mindful of the risk of upsetting fragile global financial markets and perhaps throwing a wrench into the U.S. economic recovery.Jonathan Ernst/Reuters
It's not often you can say that a mid-summer announcement from a stodgy government institution could signal the most important policy turning point for the global economy this decade. But the U.S. Federal Reserve Board's interest-rate decision this week might do just that.
Or, it might not.
Economists generally agree that when the Fed's policy-setting Federal Open Market Committee meets on Tuesday and Wednesday, a September interest-rate hike will certainly be on the table, as an improving economy and a high-octane labour market prompt the Fed to consider lifting its key rate from its record-low range of 0 to 0.25 per cent.
It would be the first rate hike from the world's most powerful and influential central bank in nine years, and the first rate change of any kind since it cut rates to the bone in the depths of the financial crisis and Great Recession in late 2008. This long-anticipated event has been coined "lift-off" by central bank watchers, as it would launch a new cycle of rising interest rates that could last for the next few years.
Though the FOMC wouldn't formalize such a rate increase until its mid-September meeting, it's widely expected that given the gravity of this event, the Fed would signal its intentions now – one meeting in advance of launch. The signal may be subtle – the changing of a few choice words from the FOMC's previous rate statement in mid-June, as is the Fed's communications tradition – but it would nevertheless reverberate throughout global financial markets.
That is, if it happens. U.S. economists surveyed by Bloomberg are split right down the middle on whether lift-off will begin in September. And the U.S. bond market is even more doubtful, only pricing in a small chance of a September hike. Market prices indicate that traders are still betting the Fed will hold off until early next year.
While the small contraction in the U.S. economy in the first quarter of this year created some uncertainty about whether the U.S. economy was strong enough to justify reducing the stimulus from interest rates, the data since then suggests that growth has bounced back convincingly from what now looks to have been a temporary and largely weather-related slowdown. The most compelling evidence comes from the labour market, where job growth averaged a solid 240,000 a month in May and June and the unemployment rate has fallen to 5.3 per cent, a postrecession low. Last week, the U.S. government reported that weekly new jobless-benefit claims were at their lowest in more than 40 years.
Given that maximizing employment is one of the Federal Reserve's primary mandates, the rapid pace of labour-market growth makes a strong case for easing the foot off the interest-rate gas, which has been running full throttle for nearly seven years.
The Fed has indicated that it leans toward caution in beginning to raise interest rates, as it remains mindful of the risk of upsetting fragile global financial markets and, by extension, perhaps throwing a wrench into the U.S. economic recovery. However, it increasingly looks as if its caution will manifest more in the form of a more gradual pace of rate increases once it starts the hiking cycle, rather than necessarily a delay in lift-off.
Indeed, in her recent testimony to Congress, Fed chair Janet Yellen indicated that delays in lift-off could run the risk that the Fed "might be forced to move aggressively once it starts."
"However, if it moves sooner, that could allow it to proceed gradually and observe how the economy and markets respond," she said.
The Fed's preparations for rate hikes is in stark contrast to Canada's central bank, which recently cut its key rate for the second time this year. The Bank of Canada will get to see a major piece of data Friday as Statistics Canada reports gross domestic product for May, shedding additional light on just how slow the Canadian economy has been running.
Canada's real GDP declined in each of the first four months of 2015, and key data already released for May on trade, manufacturing and wholesale trade suggest that the slumping economy didn't bounce back in any meaningful way in the month. Most economists, including those at the Bank of Canada itself, believe that GDP probably shrank for the second quarter as a whole, adding to the 0.6-per-cent annualized drop in the first quarter, as the impact from oil's plunge looks deeper and longer-lasting than originally hoped.
But a bright spot for May emerged last week, with retail sales posting an impressive 1-per-cent gain from April. The month also showed very strong employment numbers and a surge in housing starts. It might not be enough to lift May GDP into positive territory, but a flat reading for the month could be in the cards.