Markets are now so in thrall to central banks that their every utterance, no matter how banal, vague or contradictory, is splashed across the press. Last week, the spotlight was on US Federal Reserve chair Janet Yellen. She “is not noted for her specificity”, as Alastair Winter of Daniel Stewart puts it, but she actually said something quite interesting this time.
She thinks that the weak economic data of recent weeks will prove to be “transitory”. Assuming the economy continues to strengthen, interest rates are likely to rise “at some point this year”. US rates haven’t risen in over a decade.
The reason this raised eyebrows was that the weak data had persuaded some that rate hikes might be delayed until as far out as 2016. Last year, the US bounced back from a first-quarter dip, and it was supposed to be a similar story in 2015.
First-quarter GDP grew by just 0.2% on an annualised basis, according to the first estimate. But a fall in industrial production last month, along with weak retail sales, prompted fears the rebound had run out of steam, while economists at the Fed’s Atlanta branch had predicted just 0.7% growth in the second quarter.
But the Fed seems to think there’s no reason to worry. Fears of stagnation were overdone, says Paul Ashworth of Capital Economics. There hasn’t been much hard data on second-quarter activity yet, and in any case there is no obvious reason why the recovery should have been derailed.
A relatively closed economy such as the US would not be unsettled by a strong currency. The US shrugged off a fiscal tightening worth 7% of GDP between 2010 and 2014. If the recovery survived that, “it can survive almost anything”.
Meanwhile, the labour market is getting tighter, with wages and salaries rising at their fastest rate in three years and unemployment at a post-crisis low. Core inflation (stripping out food and energy costs) has risen to an annual rate of 1.8% after a 0.3% rise in April, the biggest monthly jump in three years. “The Fed can’t wait forever to raise interest rates,” as Ashworth says.
Indeed, even though it at least seems less inclined to postpone rate hikes now, central banks have never been much good at withdrawing liquidity before economies and markets overheat. So an unexpected jump in inflation, and steeper-than-expected rate hikes to contain it, are still the main danger to overheated markets in the months ahead.