When the Federal Reserve announced a rate hike for the first time in nine years in December, most traders and economists expected it to be the first of many as the U.S. economy solidifies its return to steady growth. The first few weeks of 2016, however, have not followed the expected path. Volatile equity markets and continued oil price declines are among the key reasons traders now expect only one rate hike from the Fed in 2016.
We sat down recently with former Federal Reserve Bank of Chicago President Michael Moskow to get his perspective on the Fed’s approach. In our interview, he emphasized that the Fed will be careful with further rate hikes, saying “it’s not going to be a series of rapid increases unless the economy starts growing at a pace much faster than it has been growing.” He also discussed with us the prospects for U.S. growth, what will drive economic performance and the impact international economies will have on the U.S. This is an edited version of our conversation.
OpenMarkets: When you look at where we are in the U.S. economy now, versus where we were a year ago, what are you looking at? Where are we in terms of our growth and where are we going from here?
Michael Moskow: It’s been a slow and sometimes very sluggish recovery that we’ve had, and that’s continued over this past year. If you’re averaging out economic growth for this past year, it’s somewhere between 2 and 2.5 percent. That is better than our potential, but it’s not really robust, and we would like it to be more robust, but it hasn’t been robust for quite some time now. We have seen a reduction in the unemployment rate, labor markets are tighter now, which is good. Inflation has been very low, primarily because of very low energy prices, and as they stabilize, inflation rates will start to go up closer to the objective of 2 percent.
OM: The Fed will continue to dominate headlines. When do you think we may see another rate increase?
MM: I think the most important thing to look at is the pace of increasing the Fed funds rate, not so much the exact month that they start to increase rates. They have said repeatedly that it will be gradual. They’ll be careful as they do that, but it’s not going to be a series of rapid increases unless the economy starts growing at a pace much faster than it has been growing.
OM: What do you think will be the drivers then as we look forward? You already mentioned unemployment, but what are some of the metrics that you’re looking at in 2016 in terms of what the FED might be picking up on?
MM: The Fed has repeatedly said it has a dual mandate; maximum employment and price stability reaching their 2 percent inflation target. Now, they don’t expect that they’ll be reaching that target in 2016, but they want to see progress in that direction, and expect to reach that target in the medium term, is what they have repeatedly said.
And if you look at their forecast, they do get there by late ’17, 2018. So, inflation will be moving in the right direction. And the unemployment rate, I expect to keep coming down in 2016, because we are growing above trend. Our participation rate isn’t high. Part of that is demographic reasons and part of it is just the nature of this recovery.
OM: What are some of the drivers that may help the economy, whether it’s housing, continued retail growth, or something else?
MM: Consumer spending is the most important driver of the economy, it’s roughly two-thirds of the economy. And as incomes go up, as they have recently, that’ll help improve consumer spending. The other side is business spending. Businesses have been reluctant to make investments in capital, both structures, facilities and equipment. If we saw more business spending, that could be a real boost to the economy.
Housing has improved over the past year. We’re moving in the right direction. We’re not yet up to the level that we would like to be, but we really have made progress and we’re definitely off the low period that we were several years ago.
OM: You’ve spoken a few times about the sluggishness in the economy. What’s been holding it back?
MM: I think it’s the nature of the recession that we had. We had a recession caused by a financial crisis. It wasn’t caused by the typical causes of a recession. It’s driven by a financial crisis, we were living beyond our means basically. We had too much debt, and we now are sort of de-leveraging and we’re still going through the process of de-leveraging, and we probably have a ways to go yet. Particularly, you look at consumer debt, consumer debt levels are still quite low by historical standards.
Credit card debt is low, mortgage debt is low, the only portion of consumer debt that’s high is student debt, and that owed to the government.
OM: Let’s talk aobut the impact of other regions, meaning the EU or perhaps China and some of the other Asian influences on the U.S. economy. How are you looking at international growth or international stagnation as it affects the U.S. economy?
MM: Growth outside the U.S. is slow, and you look at the worldwide growth, there’s no question it’s slow in just about every region of the world. Europe is better, but it’s still very slow. Japan, very slow. China is slowing, and certainly Latin American countries are slowing as well. This affects U.S. exports, and does effect our economic growth.
The dollar has been stronger because of the relative success of the U.S. economy, and that adversely affects our exports, but what it does is it lowers prices for consumers in the United States, and enables them to spend more.
OM: You mentioned that the Fed’s going to continue to take a slow and cautious approach. What does that mean for bond markets, especially if the Fed continues raising rates?
MM: It’s very hard to forecast the bond market. There are many buyers and ellers in the bond market that ultimately determine the price of bonds and the interest rates on these longer term bonds. The Fed can control the short term interest rates; it can’t control the longer term rates. So, I think it’s, you’ll see people monitoring what the Federal Reserve is saying and what they’re doing on an ongoing basis with a great deal of attention, and we’ll see how the markets react to this.