The Fed tightens just as the economy weakens
The Federal Reserve, as expected, raised interest rates by 0.25 percent on Wednesday for the second time in three months -- a dramatic quickening of the prior pace of just two rate hikes in the last 10 years.
It was a “hawkish hike,” with the Fed’s future interest rate expectations drifting higher as well. Policymakers continue to pencil in another two rate increases for the rest of the year. And they now expect long-term interest rates to reach 3 percent by the end of 2019, a slight increase from their last forecast in December.
This is surprising, especially given that Atlanta Fed lowered its first-quarter GDP growth estimate to just 0.9 percent heading into the Wednesday decision, suggesting the economy could be suffering a bout of weakness. Or even something much worse: Stagflation, that horrid mix of economic weakness and inflation.
Retail sales rose in line with expectations at 0.1 percent month-over-month in February after a 0.6 percent gain in January. Yet this represented the smallest gain in six months. Core sales were up 0.1 percent vs. January’s 0.8 percent, less than the 0.2 percent February gain expected.
On the inflation front, consumer prices increased a bit more than expected, pushing the annual rate to 2.7 percent from the 2.5 percent rate in January. Core CPI, leaving out food and fuel prices, rose at a 2.3 percent annual rate.
This is a significant steepening of recent price pressure (chart above), and it supports the Fed’s decision to raise rates. However, some analysts think inflation will likely cool in the months ahead due to the recent slide in energy prices that pushed crude oil back below the $50-a-barrel threshold.
But if the 0.9 percent GDPNow estimate for first quarter growth is accurate, it would represent the weakest quarter in which rates were raised since 1987, according to Julian Emanuel at UBS.
When Fed Chair Janet Yellen was pressed on this during her post-announcement press conference by Bloomberg TV’s Kathleen Hays, Yellen said “GDP is a pretty noisy indicator” and talked up ongoing evidence of labor market tightness (potentially leading to an acceleration of wage inflation), especially with demographic headwinds (retiring baby boomer) likely to weigh on labor force participation.
She also noted in her statement that measures of sentiment -- based on survey data and separate from the “hard data” readings like retail sales, for instance -- had improved. Indeed, measures of confidence for consumers, businesses and investors have been surging since the election on hopes of fiscal policy tailwinds from tax reform and deregulation.
But this depends on still contentious political climate in Washington. On the ground right now, the fact remains: The economy shifted down a gear just as the Fed tightened the monetary policy noose.
