US Fed Eyes More Rate Hikes Despite Trade, Household Debt Woes

Kristian Rouz — Policymakers at the US Federal Reserve say they will continue the current policy course of gradual increases in base borrowing costs, coupled with reductions in the Fed's bond portfolio

In several separate statements, Fed officials acknowledged the US economy is facing a challenge due to international headwinds, but suggested that the strength of the domestic market would help offset such risks.

Fed policymakers have been closely monitoring the developments in international trade and their effects on US GDP growth. Over the past several months, Fed Chair Jerome Powell has expressed confidence that economic expansion would continue well into the coming two years, coupled with the declining jobless rate, robust job creation, and rising wages.

However, some ‘red flags' might have already emerged in the Fed's otherwise rosy economic outlook.

"We are at a point now where we really need to be especially data dependent," Fed Vice Chairman Richard Clarida said. "I think certainly where the economy is today, and the Fed's projection of where it's going, that being at neutral would make sense."

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Clarida's remarks suggest Fed policymakers are not willing to increase base borrowing costs above the so-called ‘neutral interest rate‘ — or the level of the benchmark rate that neither supports nor hinders economic growth. The neutral rate is estimated at between 2.5-3.5 percent.

The Fed's borrowing costs currently stand at 2.00-2.25 percent.

Clarida's remarks come just several weeks after Fed officials said they are considering moving rates into restrictive territory to ensure more balanced and long-term sustainable economic growth. The Fed's attitude might have changed, however, after the International Monetary Fund (IMF) warned of an upcoming global economic slowdown, which could affect the US.

"The recent weakening in the global manufacturing PMIs (Purchasing Managers' Indices), particularly in China, suggests that the current strength of the (US) factory sector is unlikely to be sustained," Andrew Hunter of London-based Capital Economics said.

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In the wake of Clarida's remarks, some economists suggested that the Fed might undertake an additional two to six interest rate hikes, after which the US central banking system could take a break from decisive policy action, and review the performance of the American economy.

With a December hike still likely on the table, next year will most likely see two or three hikes — unless the Trump administration successfully enacts its second round of tax cuts and long-anticipated infrastructure package.

These two measures would mean an even greater accommodation on the fiscal policy side, requiring tightening on the monetary side to offset risks to US financial stability.

However, some say partisan politics in Congress might prevent US President Donald Trump's fiscal initiatives from becoming a reality, meaning the Fed wouldn't have to tighten its policies quite as aggressively.

For his part, Clarida also said the threat of a global slowdown should compel both the Fed and the Treasury Department to act with greater caution.
"There is some evidence of global slowing. That's something that is going to be relevant as I think about the outlook for the US economy, because it impacts big parts of the economy through trade and through capital markets," Clarida said.

Meanwhile, a separate report from the Federal Reserve Bank of New York found that total US household debt had risen to a new record high of $13.5 trillion. Officials warned the rising indebtedness is weighing on effective consumer demand, as Americans have to allocate more and more money to service their previous obligations.

The Fed also said the rising household debt could cripple the pace of broader economic expansion, as consumer demand is driving some 70 percent of the US GDP.

In yet another separate statement, President of the Federal Reserve Bank of Dallas Robert Kaplan said an expected economic slowdown in Europe and China could eventually affect the US due to the close trading relations between their respective markets.

"It's my own judgment that global growth is going to be a little bit of a headwind, and it may spill over to the United States," Kaplan said.

For his part, Chicago Fed President Charles Evans said he believes Fed rates should stand at 3.25 percent, which would require four incremental hikes, to adequately offset the challenges to financial stability without derailing the ongoing economic expansion.

He said the risks to global economic growth could be exaggerated, as lion's share of the concern widespread amongst investors and economists could be purely speculative. Evans said macroeconomic fundamentals remain strong.

"There's not a great headline" about risks to US economy now, Evans said. "International is a little slower, Brexit… housing market, I think, all of those are in the mix for uncertainties that everybody's facing. It's not enough to upset or adjust the trajectory that I have in mind."

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All these contradictory reports might point to heated debates on the Fed's policy board over the coming months. The central bank is also expected to continue its deregulation effort, which, unlike interest rate hikes, would support a quicker economic expansion.