In fact, the day-to-day volatility in the international financial markets is reflective of the uncertainties among investors on the exact timing of the Fed normalising its interest rate.
“Although the Fed has attempted to guide the markets not to read too much into its key word of ‘patience’ in timing its Fed funds rate lift-off, the continued rally in the US dollar exchange rate across broad currencies suggests that the international financial markets are still very bullish of a sooner-than-expected US interest rate hike,’’ noted Manokaran Mottain, chief economist, Alliance Bank.
However, the Fed could also be facing a dilemma as it juggles global and domestic considerations.
“An even chance for the first rate hike is likely to happen in June. With a steady economic growth path, backed by continued improvement in the labour market amid muted inflation or falling energy-induced disinflation, I think the Fed is getting closer to normalise the near zero interest rate that has been kept for seven years since December 2008,’’ said independent economist Lee Heng Guie.
The signal for a change in the Fed’s policy stance via the removal of the word “patience” could appear at its next post-meeting communique on March 17-18.
“It would be as early as June, in my view. The non-farm payroll numbers look good, and the jobless rate is heading towards the non-acceleration inflation rate of unemployment or NAIRU (which refers to a level of unemployment below which inflation rises),’’ said Malaysian Rating Corp associate director of economic research/ chief economist Nor Zahidi Alias.
No doubt, there are some concerns – the low wage growth, under-employment and low inflation.
“Overall, we are looking at a much improved US economy. Consumer sentiment has been bullish, and will keep supporting the headline growth this year,’’ said Zahidi.
Some expect the rate hike to happen a bit later.
“We expect the Fed to start raising interest rates in September by a total of 50-75 basis points between then and the end of 2015,’’ said Maybank Investment Bank chief economist Suhaimi Ilias.
The much-worried-over downside trend for oil price seemed to have settled, said a senior economist. “Looking at the recent economic data and, in particular, the latest jobs data it somewhat increases the possibilities for the Fed to start raising rates by June 2015, with a stronger chance for rate hike in September,’’ said the economist.
“I think it is still data dependent and will not be just based on the unemployment data but also on wages and inflation.
“Looking at it, it may happen only in the second half of 2015,’’ said RHB Research Institute head of Asean research Peck Boon Soon.
However, the Fed is expected to be gradual in its monetary policy normalisation to ensure that the US growth momentum is sustainable.
“We also take the view that the Fed wants to see that its dual mandate of full employment and price stability is on track: that the current strong employment figures are accompanied by signs of the inflation rate moving towards its preferred level of 2%,’’ said Suhaimi.
However, some view the Fed may adopt a more cautious approach, moving forward, as it has to consider various external and domestic headwinds in timing its rate hike.
‘’Externally, the Fed has to consider the increasing divergence in global monetary policy as major central banks have slashed their benchmark rates recently.
“In addition, the Fed has to make a judgment call on whether the US economy is able to sustain its growth after the gains in the recovery, post global financial crisis, while the rest of the major economies are facing respective subdued growth prospects.
“Domestically in the US, the Fed’s missing piece for an interest rate lift-off is the low inflation rate in recent months. The consumer price indices in January 2015 have been below the Fed’s target of 2%,’’ said Manokaran.
In short, while the Fed is much more confident of its economic recovery in light of the strong gains in its labour market, how much more “patience” it can tolerate is the Fed’s biggest dilemma.
There are views that even though inflation is below target, the optimal policy is to normalise interest rates gradually, especially with the unemployment rate trending lower.
“As of now, the Fed’s mandate of achieving considerable progress in the labour market and unemployment rate target of 6.5% has been met,’’ said Lee.
February’s robust job growth of 295,000 jobs is the 12th straight month that the economy has added more than 200,000 jobs.
“The unemployment rate of 5.5% is the lowest level since May 2008. Continued progress in the labour market is expected, going forward.
“Bolstering employment is only half the Fed’s dual mandate; its other mandate is to keep inflation at near 2%, which is far-fetched,’’ said Lee.
A strong dollar, falling energy prices and disinflationary conditions around the globe are helping to mute inflation pressures.
“That said, wages should pick up if job growth continues to strengthen.
‘’As such, with the unemployment rate at 5.5% or trending lower in the months ahead, the optimal policy is to normalise interest rates gradually, even though inflation is below target.
‘’In its most recent estimate, the Fed has placed full employment at somewhere between 5.2% and 5.5%, a level below which the supply of workers is so tight that wages will rise and create an inflationary spiral,’’ said Lee.
As long as there is speculation on timing of the US rate hike, market turbulence will continue.
The potentially worst affected economies should be preparing themselves on measures that can be taken in terms of capital outflows and impact on their currencies against potential further US dollar strength.
Columnist Yap Leng Kuen reckons that domestic and global issues be considered in the face of potential movement in global liquidity.