When talking about the Federal Reserve’s interest rate increase, market participants and observers have always been asking the never-ending question: “Will they do it soon or won’t they?”
These individuals also feel the need to interpret and analyze each and every word that the Federal Reserve Chair says in each speech and Federal Open Market Committee statement.
However, instead of parsing every utterance from the Fed, let me recommend a better approach. Just take a small, yet significant part of what the Fed always says about hiking interest rates—that it would be “data-dependent.” Rather than delving deep into the words of Fed Chair Janet Yellen, take a step back and try to have a bird’s-eye view of what’s actually happening today. Doing so will give you a hint of what will most likely occur in the future.
The central bank has a dual mandate to manage inflation and to boost employment in the United States. When the Federal Reserve states that the decision regarding interest rate hike is data-dependent, this is precisely what it’s talking about. Now, let us take a look at some factors in the current environment.
Inflation
In terms of inflation, it is presently running at less than the 2% target of the Fed. Moreover, the US Dollar Index is the strongest against other major currencies in nearly 12 years. Hence, you should dismiss the idea of hyperinflation.
US Employment
The labor market of the United States has been at its healthiest in many years. During the previous year, almost 250,000 new jobs were added every month. In the past 4 years, the average number was at 210,000. Aside from that, the unemployment rate has declined dramatically from 10% in 2009 to 5.3%. The July nonfarm payrolls report, which is scheduled to be released this week, is expected to show that there are over 11 million jobs that were added since the Great Recession ended in 2009.
Stock Market
The major stock indices in the US are within 5% of their record highs. The US companies’ balance sheets are at their healthiest in decades, and as you probably already know, the health of stocks is a reliable indicator of growth. Moreover, it also supports normalization of interest rates.
Overall US Economy
When you consider the past five years, the economy of the United States has grown. Although it is at a slower pace than what is ideal, it is still faster compared to what most people have expected.
Even if the growth in the Gross Domestic Product has been erratic -- home ownership is at its lowest level in almost 50 years, prices of key commodities including oil, copper and iron have slumped and there are issues in China and the Eurozone that may affect the United States -- the present data seem much stronger than any other in the midst of a crisis. Moreover, the presence of positive economic indicators would be enough reason for the Fed to put its ultralow-interest-rate policy to an end.
Now, it’s your choice if you will analyze and try to give meaning to each word from the Fed, or opt take a look at the available data. For me, I prefer to do the latter and I believe that interest rates will start to normalize before this year ends.