Will the US raise interest rates in September?

No. Based on the volatility we’ve been witnessing in the global markets, it seems unlikely that the Fed will hike interest rates in the September review.

One of the external factors that the RBI has been watching closely for taking a call on its own interest rate stance is the behaviour of the US interest rate. Since Jan 2015, increasing number of Fed members, policy analysts and traders have opined that an interest rate hike in the US is a question of when, rather than of.

The markets were largely expecting that the Fed would raise its interest rates in the September review. The RBI, which did not slash rates in last month’s policy review, also seemed to be waiting for some kind of a cue coming in from the Fed, before it could give a reduction on rates.

Pre-volatility, why were the markets expecting the Fed to hike rates?

The basic argument was that the jobs data from the Labor Bureau has been very good in the run-up to August. Unemployment rate in the US seems to be around 5.5% (see chart below). Now, the Federal Reserve believes that the “Natural Rate of Unemployment” for the US stands between 5% and 6%. This is the unemployment rate faced by the US when the labor resource is almost fully employed. Thus, any further reduction in the unemployment to say, 5%, would eventually spark off wage inflation and feed into an overall price hike.

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Has the inflation in the US been very high?

Actually, no. But since monetary policy is as much about managing inflationary expectations as it is about curbing the actual inflation, the Fed was taking a view that the current jobs data seemed to show a trend of future potential inflation. It would be necessary to curb this potential overheating by hiking interest rates.

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How has the dollar been moving vis-a-vis other currencies in the past one year?

Now this is one trend which is really interesting. If we observe the US Dollar Index (which is 6 currencies weighted against the dollar), we find that the dollar has pretty much strengthened against a basket of currencies since September 2014. The aggregate strengthening of the dollar over the past one year works out to a hefty 14%. So for a year now, the dollar has been getting stronger, which has been hurting the exports movement from the US.

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So what has changed now?

Many things.

  • Since the Emerging Market economies have all witnessed considerable depreciations in this week, the dollar will emerge even stronger once the dust starts settling down. This by itself, should help the economic system to move from overheat to a more calm economy.
  • Add to this the fact that cheaper exports and cheaper oil should take the inflation southwards. Since the Chinese growth rate is expected to be soft in the coming fiscal, the biggest buyer of commodities will be showing low demands. This will cause commodities to remain low for a while, helping inflation to be controlled for all economies including the US.
  • Finally add to this the fact that the Chinese Central Bank PBOC has reduced its interest rates in an attempt to excite the real sector fundamentals into growth. Even with the US interest rates untouched, it really creates a differential between the US interest rates and the Chinese interest rates, which effectively helps in controlling overheat and dampening inflation in the US.
  • One last point before I wind up. Interest rates are changed in order to give critical direction to the economy. By that I mean, that interest rates are used as an instrument to change values in the real sector of the economy. However, that they have an impact on financial markets is also a given. When markets are already jittery and on tenterhooks, it would be pointless to rattle them some more by hiking the rates at this point.

There seems to be no case left for a September hike anymore.

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2 thoughts on “Will the US raise interest rates in September?

  1. Hi Mam,
    “Any further reduction in the unemployment to say, 5%, would eventually spark off wage inflation and feed into an overall price hike”. Could you please explain how. Thanks

    Like

    • Hi Urvashi!
      The natural rate of unemployment is a situation where almost every labor resource is fully employed. So, further growth would mean that we’d have to pull the labor from existing employment options by offering higher wages. Thus, when an economy moves towards the natural rate of unemployment, policy makers start expecting the wages to push up.

      Like

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