As a general rule, economists tend not to change their views dramatically based on a single month’s worth of data, but in this case many have been willing to make an exception.
In the space of just two weeks, a trio of surprising reports has caused many to abandon long-held forecasts and declare that the Federal Reserve is likely to raise short-term interest rates months earlier than previously anticipated. On financial markets, investors already have driven up long-term interest rates, bringing the latest brief round of mortgage refinancing to a grinding halt.
But not everyone is ready to jump on the rate-hike bandwagon just yet. And despite signs that the economy is gaining steam faster than expected, Fed Chairman Alan Greenspan is likely to be cautious about the economic outlook when he testifies before Congress next week, some analysts believe.
“Do not expect a signal that monetary policy tightening is imminent,” Goldman Sachs chief U.S. economist Bill Dudley said in a research note. “We think (Greenspan) will acknowledge the improvement in the economic outlook. However, he is also likely to describe the improvement in the labor market as tentative.”
Dudley is among the few economists still standing by the conviction that the Fed will stay on hold until 2005, although he clearly is wavering.
“Further sharp gains in payroll employment growth that tightened the U.S. labor market could force us to capitulate at some point,” he said.
Others already have capitulated.
Ethan Harris, chief U.S. economist at Lehman Bros., now expects the Fed to raise the benchmark overnight rate in September rather than January. Former Fed Gov. Lyle Gramley, a consultant with Schwab Washington Research Group, expects a move in June or August rather than December. Paul Kasriel, economic research director at Northern Trust, said the Fed will make its first move in August, not next year. That completed a flip-flop, as earlier this year Kasriel had been calling for an August Fed move before he changed his view.
“It’s the chameleon model of forecasting,” he said cheerfully. “The forecast turns the color of the latest data that falls on it.”
There are reasons to believe Fed policy-makers may be slower to change their colors. After all, they have been promising for months that they will be “patient” in deciding when to raise interest rates. And so far the data showing stronger-than-expect growth mainly reflects only one month’s results, a point underscored Friday by Alfred Broaddus, president of the Richmond Fed.
“I think at this stage of the game, speaking strictly for myself, we need more confirmation,” he said. “We must wait a little longer before we make judgments on whether or not the reports of the March economic data will persist or not. I think it will, and the likelihood is pretty high.”
He said the Fed is “some distance” from conditions that would require a rate hike.
The surprising run of strong data began April 2 with the report that the economy added 308,000 payroll jobs in March, the strongest result in four years. But many analysts considered that a “catch-up” report after months of weakness, and there certainly was no sign of upward pressure on wages.
Then this week came the report of surprisingly strong retail sales, although the result was somewhat inflated by an unusual spike in sales of building supplies. But Wednesday’s report of a surge in consumer inflation, coming after two months of creeping increases, was not so easy to explain.
The “core” consumer price index, which excludes volatile food and energy prices, rose at a 2.9 percent rate in the first quarter, up from 1.1 percent last year. That kind of rapid shift in core inflation is rarely seen, said Harris of Lehman Bros.
“Given how sudden the shift in the data has been, the confidence level in predicting the economy or Fed is quite low,” he said. “We were feeling very comfortable with our call of the Fed on hold for a long time. Then all of a sudden you get a very impressive string of numbers and you start to question whether you really understand what is going on.”
But the Fed has been actively working to boost the inflation rate at least since last May, when it first began warning of the dangers of deflation, or falling prices. And Fed Gov. Ben Bernanke, who has led the move to head off deflation, does not seem concerned about rising prices.
“I think that currently the output gap and productivity are both factors that are going to help keep inflation under control over the next couple of years,” he said Thursday at a luncheon in Chicago.
“This is exactly the environment the Fed was trying to create — why would they stand in front of it?” said David Rosenberg, chief North American economist at Merrill Lynch. He is standing by his view that the Fed will not move this year. “Nothing detracts from the potential cloud that looms in the second half of the year,” he said.
After GDP growth of 6.2 percent in the second half of 2003 and an estimated 5 percent in the first quarter of this year, most analysts expect growth to slow in the second half and into 2005. A wave of fiscal stimulus from income tax refunds will have dissipated by then, and there is likely to be little of the refinancing activity that has buoyed the economy for the past two years.
In the past, the Fed typically has waited to raise rates at least until employment recovers to pre-recession levels. But that easily could take until next year, because the economy continued to shed jobs long after the recession ended in November 2001.
Kasriel, among others, contends that the Fed will have to act sooner this time around because the benchmark federal funds rate is so unusually low at 1 percent, the lowest level since the 1950s and now well below the rate of inflation.
“We know in our hearts — in our brains — that this is not the right rate, and the right rate is higher,” he said. “We’re only a couple of strong monthly economic reports away from the Fed having to seriously consider raising rates.”
