Don’t count on rate hikes starting in the US this year.
Yes, the Federal Reserve has made it quite clear that it wants to begin a new interest rate cycle in 2015, preferably around mid-year, to get rates off zero. Virtually every economist and market forecaster expects US interest rates to start rising in 2015.
But can the Fed really go in the opposite direction to every other country?
The US dollar has already appreciated 16.5 per cent on a trade-weighted basis since July 1 last year while the Fed just talked about raising rates. Yet since the start of last year the US 10-year bond yield has, incredibly, almost halved. In other words, money is already pouring into US assets as a safe haven and, lately, into gold as well.
This morning, the Bank of Canada shocked markets with a 25 basis point rate cut, to 0.75 per cent, citing the fall in the oil price as an “unambiguous negative” for the Canadian economy.
Last night, the Bank of England’s minutes revealed that the two members of the Monetary Policy Committee who had been calling for rate increases in the UK have now abandoned that call.
Last week, the Swiss National Bank ended its currency peg and cut the official interest rate by 50 basis point to minus 0.75 per cent.
Tonight, the European Central Bank is expected to announce a big program of quantitative easing, or monthly bond purchases, to try to keep Europe out of deflation. European interest rates, needless to say, are going nowhere for a long time.
The Reserve Bank of Australia is now widely expected to cut rates twice this year.
Last week, the Reserve Bank of India announced an unscheduled rate cut. The People’s Bank of China is easing monetary policy. Yesterday, the Bank of Japan cut its inflation forecast and left its unprecedented monetary stimulus in place.
If the US Fed goes it alone this year and raises interest rates, the rise in the US dollar since July last year will have been merely a foretaste of what’s to come. The dollar’s rally will risk driving inflation even lower -- potentially into full deflation -- and risk serious damage to the economy.
There is probably nothing US authorities can do to prevent a ferocious dollar bull market anyway. The currency war has turned into America versus the rest of the world and the US is paralysed by a most exquisite dilemma.
It keeps overestimating both unemployment and inflation -- it got both wrong in 2013 and last year, with employment stronger than it expected and inflation weaker.
That’s not supposed to happen. Under central banking theory and practice, low unemployment is supposed to result in higher inflation, not the other way around, so it should have got at least one of them right.
What’s more, there is no reason to think that’s going to change this year.
A fortnight ago the Bureau of Labor Statistics reported that payrolls had expanded by 252,000 in December and that the unemployment rate fell from 5.8 to 5.6 per cent.
Then, last week, it reported that consumer prices FELL by 0.4 per cent in December -- the most in six years. Core inflation, excluding oil, has fallen below 1 per cent.
The Fed really is in a bind now. With everyone else either cutting rates or printing money, and with US inflation already very soft, if it raises rates this year it risks a devastating rise in the US dollar.
Yet on every other measure than the CPI the US economy is powering along: Unemployment below 6 per cent and falling, business investment rising and intentions accelerating, consumer and business confidence both growing strongly and, this week, the IMF raised its forecast for US growth while reducing it for the world.
What’s a poor Fed to do? Not raise rates in 2015, that’s what.