FOMC message

Tighten we will, but not as much as you fear!

There was a lot of furor about the Fed dropping the word “Patience” from its post FOMC meet discussions and statements. It is already worrying analysts that dropping the word “Patience” may signal rapid tightening of rates. That is not necessarily the case.

Unemployment is the key…

One of the key metrics that the Fed will look at is the rate of unemployment. That currently stands at 5-5.2%, down from around 5.7% last year. The Fed will be comfortable raising rates after unemployment comes down much further. Fed feels that raising rates when there is still a job slack in the economy may not be a great idea. While the employment data may be on track, the Fed will still prefer to bide its time.

GDP growth is elusive…

The Fed would prefer to raise rates aggressively once the visibility on growth is seen. The last quarter figure of 2.2% comes in the backdrop of a 5.5% growth in the previous quarter. While this stands out in the developed world, the US Fed feels that growth may have peaked out in the US. Thus sharper upsides to growth look unlikely from these levels. That means the economy heating up due to a combination of higher wages and higher GDP growth is unlikely to be a tangible risk in the short to medium term. At best, US growth may be stable at 3%.
Inflation is actually going lower…

Inflation is another key metric that the Fed tracks. The Fed will be comfortable raising the rates when inflation hovers closer to 2%. That is still a long distance away. With the oil prices weak and looking to move further down, it is a matter of anybody’s guess that inflation is unlikely to get back to its 2% level any time soon. That is one more reason for the Fed not to be aggressive on rates in the US.

Of course, exports are the key…

That is probably the biggest worry for the US policymakers. Exports showed deceleration for the first time since 2009. This has largely been driven by a strong dollar, which has appreciated 26% in the last one year. Global players like Microsoft, Intel, Pepsi and Coca Cola have been complaining about export competitiveness for quite some time. The clamor us only getting louder!

The moral of the story is simple. Tighten they will, but much slower than originally anticipated. It will be nothing close to what happened in 1994. The Fed has already scaled down its year end guidance of Fed rate for 2015 from 1.125% to 0.625%. And the rates for the next 2 years are also scaled down, although the long-term rate is maintained at 3.75%. The panic may be over. Global markets can breathe just that little bit more freely; for now! ©

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