Is the Fed on the Right Track?

I’ve pointed out many times here on the Blog that the Federal Reserve (Fed) missed its window to raise interest rates nearly three years ago, when conditions were ripe for a hike. After hearing Fed Chief Janet Yellen’s comments last week, I wanted to point out that despite the central bank’s slow-to-act approach, the Fed is doing exactly what it should be doing given today’s economic and market environment.

Fed policy today is appropriately easy

In her comments last week, Yellen emphasized that the central bank will “proceed cautiously in adjusting policy,” raising questions about whether the Fed’s second rate hike will happen this spring. She also lamented that there is an “asymmetric” opportunity set for conventional policy, which we believe is a direct result of the central bank’s previous hesitation.

For now, I believe the Fed’s current wait-and-see stance is clear, appropriate and appreciative of global economic, financial and inflationary conditions. As the chart below shows, the world is feeling the crunch of a stronger U.S. dollar (USD) and slower growth in emerging markets (in China in particular) that are largely pegged to the USD. Indeed, global growth priced in USD is at the worst level in years.


By remaining on hold and pointing out that it could adjust rates back to near zero “if the expansion was to falter or if inflation was to remain stubbornly low,” the Fed is signaling it will tolerate higher inflation in the short run. This, in turn, should help keep the USD from strengthening too much and ease some of the pain on the global economy.

In other words, the global risks today, particularly the growth risks out of China, coupled with super aggressive easy monetary policy from the European Central Bank (ECB) and Bank of Japan (BoJ) require easier policy from the Fed.

It’s just too bad the Fed didn’t initiate liftoff a couple of years ago, when there was an optimal open window for beginning rate normalization. A move then would have given the central bank more room now for maneuvering. Today, the central bank must contend with U.S. payrolls growth that is likely peaking, a moderating U.S. economy and challenging economic and financial market conditions abroad.

Further, temporary U.S. hiring has started to slow, which historically has been a signal of future weakness in payrolls growth. All these dynamics put the Fed in a difficult position regarding normalizing rates. That said, the March jobs report, which beat expectations and reiterated that labor markets are as robust at any time in a generation, leads us to believe all the more that this is a Fed that will move at most two times this year, with the potential for no movement at all in policy rates. I’ll have more on this when I share my perspective on the latest jobs report next week on the BlackRock Blog.

Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Global Fixed Income and is a regular contributor to The Blog.

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