Fed Officials Reassess U.S. Outlook Amid Global Weakness

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U.S. Retail Sales
A shopper browses merchandise at a Banana Republic LLC store in San Francisco, California, U.S., on Dec. 18, 2014. Last month’s decline in U.S. retail sales, the biggest in almost a year, suggests that Americans may be cautious about spending a windfall from cheaper gasoline even as the job market improves. Photographer: David Paul Morris/Bloomberg

Federal Reserve officials are starting to reassess their outlook for the economy as global weakness and disappointing data on American consumer spending test their resolve to raise interest rates this year.

San Francisco Fed President John Williams last week said he will trim his U.S. estimate because of slower growth abroad. Atlanta’s Dennis Lockhart said Jan. 12 that he advocates a “cautious” approach to rate increases and inflation readings “may be pivotal.” Both are voters on the Federal Open Market Committee in 2015 and repeated that rates could be raised in the middle of the year.

Weakness in Europe, Japan and China has dimmed the outlook for the world economy, with the International Monetary Fund and World Bank reducing their estimates for global growth. Last month’s decline in U.S. retail sales, the biggest in almost a year, suggests that Americans may be cautious about spending a windfall from cheaper gasoline even as the job market improves.

“You have some cracks appearing in the official line that lower oil prices are good for the U.S. economy and that the U.S. can grow even if the global economy is weakening,” said Thomas Costerg, an economist at Standard Chartered Bank in New York. “There are headwinds.”

The Bank of Canada today unexpectedly cut its target rate by a quarter-point to 0.75 percent in response to the drop in oil prices, which it said will be “negative for growth and underlying inflation in Canada.”

FOMC Meeting

Fed officials will discuss the outlook when they meet next week, though they aren’t scheduled to release their next set of economic projections until March.

Even small cuts to their forecasts are likely to reinforce the message that the FOMC can be “patient” as it plans to raise interest rates for the first time since 2006. Chair Janet Yellen indicated in her December press conference that rates are unlikely to be raised “for at least the next couple of meetings,” or not before late April.

Federal funds futures markets now show only a 15 percent chance the benchmark interest rate will be 0.5 percent or higher in June, compared with about a 30 percent probability at the start of the year.

Macroeconomic Advisers LLC, the St. Louis-based economic forecasting firm, has pushed its estimated date for the first rate increase back to September from June.

Fed officials still have plenty of reasons to stick to their mid-year estimate for a rate increase. The unemployment rate stood at 5.6 percent in December, just above the top end of the Fed’s 5.2 percent to 5.5 percent estimated range for full employment. Private forecasters expect growth of 3.2 percent this year, enough to pare down excess slack and provide a floor for prices.

Communications Challenge

Even so, Fed officials find themselves confronting a communications challenge as they head into their Jan. 27-28 meeting because no press conference is scheduled and they are limited to a statement that in December ran to 734 words. The Fed chair holds press conferences following four of the eight annual FOMC meetings, with Yellen’s next appearance scheduled for March 18.

“The argument is made that there should be a press conference after every meeting, and the case for this at present is as compelling as it has ever been,” said Jon Faust, director of the Center for Financial Economics at Johns Hopkins University in Baltimore and a former Yellen policy adviser. “Things have gotten very interesting, and people will be hungry for explanations from the voice of the committee.”

Conflicting Signals

Plunging yields on U.S. Treasury debt are sending conflicting signals about the outlook for the world’s largest economy: on the one hand, they reflect stronger demand for U.S. assets as growth elsewhere falters. On the other hand, they may portend further downward pressure on inflation.

Yields on U.S. 10-year government bonds were trading around 1.79 percent today in New York, from 2.14 percent when Fed officials last met in December. Treasury rates could fall further if the European Central Bank launches a bond-buying plan as expected on Jan. 22.

Lower long-term yields could underpin the expansion as credit becomes cheaper. Mortgage applications rose 49.1 percent from a week earlier, the Mortgage Bankers Association said Jan. 14, as tumbling borrowing costs boosted demand for refinancing.

At the same time, lower yields may also signal concern that disinflation is deepening. A measure of average inflation starting five years from now tracked by Barclays stood at 1.78 percent today, down from 1.92 percent when officials last met.

Low Inflation

The Fed’s preferred inflation gauge, the personal consumption expenditures price index, rose 1.2 percent in November from a year earlier and has lingered below the Fed’s 2 percent goal for 31 straight months.

The markets are reflecting doubts about “the Fed’s ability or willingness to get inflation back to target,” said Michael Pond, head of global inflation market strategy at Barclays in New York. “The more the Fed dismisses this, the more credibility is lost.”

U.S. central bankers could update investors on their sense of slack in the economy in the first paragraph of the statement, which lays out changes in the labor market and inflation since the last meeting.

The threat of lower inflation could be addressed in the second paragraph, which describes risks to the outlook for fulfilling the Fed’s dual mandate of price stability and full employment.

Neither is likely to satisfy investors’ demands for a more complete explanation of how recent data on the economy and markets have changed the FOMC’s view, said Diane Swonk, chief economist at Mesirow Financial Holdings Inc. in Chicago.

“They don’t want to look like they have their head in the sand,” said Swonk, adding that the Fed will have to hold more frequent press conferences. “They don’t like disorderly, and some of what we are seeing in the bond market looks disorderly.”

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