Slowing foreign economies, stock market volatility and falling commodity prices could deal a setback to US growth, a Federal Reserve policymaker warned as he made the case for a modest path of monetary policy tightening.
Eric Rosengren, president of the Boston Fed, suggested that the slowdown overseas may prompt a reduction in his growth outlook in the central bank’s next forecasting round and dent his confidence that inflation will accelerate.
His words came as global stocks suffered a fresh knock amid the quickest contraction in Chinese factory activity for three years. Faltering growth in China plus days of sharp market gyrations are clouding the outlook for global growth even as the US expansion continues apace.
“These developments might suggest a downward revision in the forecast that is large enough to raise concerns about whether further tightening of labour markets is likely,” Mr Rosengren said in a speech in New York.
“Without an expectation of growth above potential and further tightening of labour markets, I would lose my primary rationale for a forecast of rising inflation, diminishing my confidence that inflation will reach the 2 per cent target within a reasonable timeframe.”
Mr Rosengren is at the dovish end of the spectrum among Fed policymakers and does not vote on rates this year, but his words are revealing of the range of views within the central bank as it tussles with the timing of the first rate increase in nearly a decade. He made no explicit comment on when he thought short-term rates should start rising, but said that he did not believe moving the timing forward or back a couple of months would make a big economic difference. His focus on the path of rate hikes rather than the timing of the first move suggested to some economists he might be more willing to accept an initial increase as long as it was combined with strong assurances that subsequent rises will be gradual.
Michael Feroli, US economist at JPMorgan Chase, said: “While the market isn’t helping September lift-off odds this week, the latest Fedspeak suggests the committee could potentially gel around agreeing to a hike at the next meeting, provided it is coupled with strong communications that the path of subsequent hikes will be gradual.”
Stanley Fischer, the vice-chair of the Fed’s Board of Governors, sought over the weekend to keep open the option of lifting rates as soon as September, but the Federal Open Market Committee is divided as to when to pull the trigger. Much will depend on the view of Janet Yellen, the Fed chair, who has not spoken publicly since testimony before Congress in July.
Mr Rosengren focused the bulk of his speech on the path of tightening after lift-off eventually occurs. He laid out a case for a “modest” path of tightening, arguing rates should rise at a much slower pace than in the previous two tightening cycles of 1994 and 2004.
The Boston Fed chief pointed out that whereas core inflation, measured by the personal consumption expenditures index, was above 2 per cent at the start of the 1994 tightening cycle and narrowly below it in 2004, when it last started lifting rates, it is now running at a year-on-year rate of just 1.2 per cent.
Growth is also running at a slower pace. And while the unemployment rate is lower than at the start of the 1994 and 2004 tightening cycles, a broader measure of joblessness which includes people working part-time for economic reasons now lies between the rates in 2004 and 1994.
Mr Rosengren said: “If one believes the broader measure of unemployment better captures slack in the economy, then labour markets would not be viewed as unusually tight for commencing the tightening cycle. This potential additional slack would also be a reason for policymakers to follow a more modest interest rate path at the beginning of a tightening cycle.”
The Fed has set itself two tests for lifting rates. One sets the need for “some further improvement” in the labour market — and Mr Rosengren said this one had largely been met. The second requires policymakers to be “reasonably confident” that core inflation measured by the personal consumption expenditures index will move back to 2 per cent in the medium term.
Here Mr Rosengren argued that recent data “have yet to indicate that this second condition will be met in the coming months”. As such, policymakers would need to rely on forecasts of higher inflation — something Mr Fischer did in his speech over the weekend. Unfortunately, forecasters have in recent years inaccurately predicted that inflation will return to 2 per cent, Mr Rosengren observed.
Being confident on inflation depends on being sure that the economy will continue to grow above its potential rate, and that labour market slack will carry on shrinking. This is where recent global developments are important, because they could trigger a sufficiently large setback in the outlook to raise questions about whether the US labour market will carry on tightening.
“Indications of a much weaker global economy would at least increase the uncertainty surrounding policymakers’ economic growth and inflation forecasts,” Mr Rosengren added.