At the Fed, spring comes early with return to new 'normal'

March 13, 2017 10:31 AM

U.S. household wealth has hit record levels. U.S. stock prices recently hit all-time highs. Inflation is nearing the Federal Reserve's 2.0 % goal, and the world economy including the once-sick Eurozone has skirted the risk of a deep new downturn

When Fed Chair Janet Yellen holds her first press conference of 2017 on Wednesday she can arguably declare a victory of sorts with an expected interest rate rise that will leave monetary policy looking increasingly normal.

The rate increase expected on March 15 will be the second in four months, a pace unseen since the peak of the U.S. housing boom in 2006. A rate hike will also bring the Fed's target rate to between 0.75 - 1.00 %age points, near the bottom of the range within which the Fed operated before the 2007-2009 financial crisis.

"You don't need any intrigue or fundamental shifts in beliefs about the economy to realize why a rate increase might be likely," Johns Hopkins University professor and former Fed adviser Jon Faust said of the central bank's plans.

"The Fed would just as soon be back to normal...Unless something really bad happens they will raise rates in March and that gets them on a path to raise rates more this year."

U.S. February employment data published on Friday further cleared the way to an interest rate rise, with the economy adding another 235,000 jobs. The unemployment rate held roughly steady at 4.7 %.

For Faust and others, the conversation is now focused on whether the Fed, when it releases new economic forecasts this week, could even raise its forecast for rate rises also.

The month of March has been cruel to Yellen in the past. At the Fed's March meetings in 2015 and 2016 the central bank downgraded its economic forecasts after inflation expectations plunged two years ago and after last year's meltdown in the benchmark S&P 500 stock index.

A year on, world stock markets have surged and even global economic laggards like Japan and the euro zone are looking better. European Central Bank president Mario Draghi gave his own mission accomplished declaration last week saying that "...our monetary policy has been successful."

If anything, market analysts, economists, and Fed officials tout the possibility of stronger economic growth, resulting from the possible impact of U.S. tax cuts and infrastructure spending, or the run-up in household wealth from rising stock and real estate values.

As a multiple of disposable income, the $92 trillion in net worth recorded among American families at the end of 2016 is the highest on record, JP Morgan economist Michael Feroli noted last week, More comforting for the Fed, markets have not just anticipated the path of interest rate rises by setting prices in markets in line with the number of rate increases for the year that policymakers expect to deliver, but reacted sanguinely to it.

As has been typical of prior monetary policy tightening cycles, the Fed's moves have been felt mostly in short-dated bond yields, with less effect on the mortgage markets or other long-term financings important to economic growth.

That's a relief for a Fed still anxious about events like the 2013 "taper tantrum", when then Fed chair Ben Bernanke said the central bank would begin reducing purchases of bonds, triggering a global bond market selloff.

When Fed officials unexpectedly rallied behind a March interest rate increase in recent weeks, the unusually blunt message was easily accepted. Investor expectations changed and short-term rates rose.

But the overall yield curve, the range of interest rates from short to long term debt maturities, showed little sign investors thought the Fed was becoming worried about inflation.

Yellen has long made job growth the priority, hoping wage growth would follow, while assuming the Fed could always tame inflation if it rose too quickly.

While in recent remarks she has emphasized the risk of rising prices, she has also remained committed to raising rates at only a "gradual" pace in order to leave loose policy in place a while longer.

IHS chief economist Nariman Behravesh said the latest job report may leave the Fed in a sweet spot, able to move ahead with its rate hike plans as employment and modest wage growth continue.

"We can expect to see the recent strength in jobs growth continue for a while longer," Behravesh said. At an annual rate of 2.8 %, "while...wage nothing to cheer about, it is not bad either."

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