They say a picture is worth a thousand words… but could a single word be worth nearly half a trillion dollars?
Based on last Wednesday’s Federal Reserve release, it appears that it can.
Investors were anxiously waiting to see if the Fed would remove the word “patient” from its FOMC statement.
Of course, it did… though Fed Chair Janet Yellen warned that removing the word “patient” doesn’t mean the central bank will be impatient with its rate hikes.
Investors considered this a sign that a June hike is unlikely, which was welcome news. The S&P 500 responded by climbing from an intraday low just prior to the Fed release to an intraday high two hours later. S&P 500 constituents gained more than $400 billion in market cap during that period.
Simply put, the Fed blinked… and based on its latest report, I’ve come up with five reasons why the Fed funds rate will stay at zero until at least September.
1. The Dollar Is Too Damn High
Perhaps the biggest reason why the Fed has pumped the brakes on its rate increase is the strong U.S. dollar. The world’s reserve currency has been on an epic run, with the Dollar Index Spot Exchange Rate (DYX) gaining more than 25% since its 52-week low in early May 2014.
That’s not necessarily a good thing for the U.S. economy, though. The dollar’s strength is putting pressure on exports, since U.S. goods become increasingly expensive for foreign buyers as the dollar goes up. Meanwhile, U.S. multinationals face declining overseas revenue as foreign currencies lose value versus the dollar.
Perhaps most importantly, though, the strong U.S. dollar is putting pressure on emerging markets that have accumulated substantial dollar-denominated debt. According to the Bank for International Settlements, the stock of dollar debts owed by non-financial borrowers outside of America has risen 50% since the financial crisis. As the dollar continues to rise, these debts become more expensive – and when the Fed eventually raises rates, the interest charged on dollar debts will go up, as well. That’s a tough one-two punch for markets that are already struggling with slow growth.
2. Inflation Remains Stubbornly Low
Inflation dropped even further below the Fed’s long-run target of 2%, and the FOMC was forced to revise its outlook downward. The dollar has contributed to this issue, since imports are cheap (and getting cheaper) as the dollar continues to rise, but energy prices are largely to blame.
You see, even though the core personal consumption expenditures (PCE) price index – a popular measure of inflation – excludes energy, the secondary effects of cheap energy are widespread. Thus, as long as the price of oil remains depressed and the dollar stays strong, inflation will likely linger below the Fed’s desired level.
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3. The Economy Stinks
The U.S. economy isn’t as strong as the Fed wanted us to believe. Of course, if you’ve been reading Wall Street Daily, you already knew that growth expectations were off base in December. Now, first-quarter gross domestic product (GDP) growth could be as low as 0.3%, according to the Atlanta Fed’s GDPNow model. Meanwhile, the Federal Reserve’s full-year growth expectations were revised downward from 2.6% to 3% to 2.3% to 2.7%.
On top of that, wage growth remains stagnant despite some indications that the labor market is improving. Even though Yellen maintained that stronger wage growth is not a prerequisite for a rate hike, it’s still clearly on everyone’s mind. Plus, the Fed lowered the long-term unemployment target from 5.2% to 5.5% to 5% to 5.2%, as the current employment level has failed to spark inflation.
Finally, U.S. retail sales have experienced their worst three-month decline since the first quarter of 2009 (when the economy was in recession). February saw a 0.6% drop, which followed similar declines of 0.8% in January and 0.9% in December. All told, sales are down 1.2% in the first quarter versus the fourth quarter of 2014. Those numbers should be a critical warning that all is not well with the economy right now.
4. Global Problems Persist
Though U.S. economic data appears to be deteriorating, the United States is actually better off than many other countries. Easy money policies are full-go in Europe and Japan, where economic performance has fallen short of expectations recently. China’s economic growth has slowed from about 14% to about 7% in the last seven years. And the Organization for Economic Co-operation and Development recently slashed its economic outlook for Canada for 2015 and 2016.
Overall, the International Monetary Fund revised its 2015 to 2016 global growth outlook downward in the latest World Economic Outlook. The updated growth number is 0.3% lower than in October 2014, even accounting for the boost provided by low oil prices.
5. The Fed Follows Ray Dalio?
Ray Dalio, the Founder of Bridgewater Associates, believes that the Fed could spark a market collapse similar to 1937 if it raises rates too quickly. In a note to clients, Dalio said that today’s environment shares many similarities with the period leading up to 1937, when interest rates had reached zero, the market had rallied on the back of monetary policy, and the U.S. economy was improving from the depths of the Depression. As the Fed began tightening in 1937, it touched off a rout that eventually saw the market drop more than 50%. Obviously, Yellen and her colleagues want to avoid a similar policy mistake. Will they end up following Ray Dalio’s advice to be “more delicate than normal”?