Stronger consumer spending and positive jobs report results have paved the way for the possibility of an interest rate hike before the end of the year. In December 2015, when the Federal Reserve raised interest rates for the first time in nearly a decade, many analysts expected that the Fed would also implement a tighter monetary policy.
In her keynote speech at this year’s annual economic symposium in Jackson Hole, Wyoming, Fed Chairwoman Janet Yellen suggested just that, saying, “The case for an increase in the federal funds rate has strengthened in recent months .”
Stocks moved slightly higher following the news, but retreated before the end of the trading session.
The debate as to when the interest rates should be raised is a battle that the Fed has been fighting since economic conditions improved following the 2008 financial crisis.
Earlier this year, the Fed projected that interest rates would increase by a whole percentage point. However, a disappointing May jobs report wiped out most of the hawkish sentiment in the central bank. U.S. employers only added about 38,000 jobs in comparison to the 168,000 expected.
The Brexit, which was voted on shortly after, forced the Fed to hold off any rate hikes until it could get a clearer picture of the economy. Investors were quick to sell off risky assets, punishing the equities markets. Despite the setbacks, the Fed is confident that it can get back on track to increase its benchmark rates as new economic data show signs of progress in productivity and inflation.
The June and July jobs reports beat analysts’ estimates, adding 287,000 and 255,000 new jobs in June and July, respectively. Most of the Brexit aftershocks have also subsided as a rally in stock prices helped move all three U.S. major stock indexes to record highs earlier this month.
One of the major reports the Fed will be keeping an eye out for, following the Jackson Hole meeting, will be the August jobs report. If the results beat analysts’ forecasts, it will be the third consecutive month to do so and it will reassure the Fed’s sentiment for rate hikes.
The Federal Open Market Committee’s Summary of Economic Projection in June shows a “70 percent probability that the federal funds rate will be between 0 and 3-1/4 percent at the end of next year and between 0 and 4-1/2 percent at the end of 2018.”
In her Jackson Hole speech, Yellen noted that her current focus is on “the policy tools that are needed to ensure that we have a resilient monetary policy framework… As I will argue, one lesson from the crisis is that our pre-crisis toolkit was inadequate to address the range of economic circumstances that we faced.”
The financial crisis exposed gaps in the previous system and brought to attention some of its shortfalls. In response, the Fed introduced several new policies, including the authority to pay interest on excess reserves as well as to make large-scale asset purchases.
In countries like Japan and Switzerland, the central banks have adopted negative interest rates in order to stimulate the economy. Negative interest rates are put in place to boost bank lending and force individuals to increase spending. By charging a subzero rate, central banks are charging a fee for keeping money tucked away in savings accounts. However, this policy has led to mixed results, as some banks are seeing their consumers saving more money than they spend.
Following Yellen’s speech, Fed Vice Chairman Stanley Fischer noted the potential for two rate hikes this year. His remarks sent the Dow Jones Industrial Average falling 53.01 points and the S&P 500 was down 3.43 points. In contrast, the U.S. currency strengthened, as currency traders saw the dollar headed for a major breakout in the near future.
Against the Japanese Yen, the U.S. dollar soared over 3 percent. Some investors, however, are still doubtful that there will even be an increase in interest rates this year. The Fed has been discussing when it should raise rates since the last time it did so took place in December 2015. The Fed has already skipped the move to raise rates five times this year and there are three more FOMC meetings remaining in 2016.
Despite positive remarks on the health and improvement of the economy so far, Yellen also commented that “the economic outlook is uncertain, and so monetary policy is not on a preset course.”
The Fed needs to be cautious proceeding with monetary policy because a shift at the wrong time could have major consequences. If the Fed continues to push off interest-rate increases, the wait could drive yield-seeking investors to emerging markets or other riskier investments that could provide higher returns. However, if the Fed does the opposite, and increases rates too soon, the move could stall overall growth.
No one can know for sure where the economy is headed. As history shows, economic projections have been blindsided by unexpected shortcomings and the only thing certain about the economy is the uncertainty.