US Federal Reserve officials want to lift short-term interest rates above zero before the year is out, based on continued improvement in the labor market and reasonable confidence that inflation is likely to increase. They are getting no help from financial markets right now.
Bloomberg’s Financial Conditions Index fell below zero on Friday for the first time in three years, which suggests market conditions are becoming more restrictive for growth.
If consumers lose confidence because their stock portfolios took a hit, or if companies have to pay more to borrow, economists inside and outside the central bank could start to lower their growth forecasts. And Fed officials’ quarterly projections for the path of their benchmark federal funds rate, which are to be updated ahead of their Sept. 16-17 meeting, could be lowered as a result of that downward revision.
The question policymakers face next month is “how combustible” financial markets are likely to be if the Fed decides to hike, Wrightson ICAP LLC chief economist Lou Crandall said.
“To the extent that global financial conditions are tightening — it is something that feeds into your forecast,” Crandall said.
The key components of this bout of market tightening have been the rise in stock-market volatility this week and the widening spread of private-sector borrowing costs.
Most of the turmoil in credit markets has until recently been concentrated in the energy sector, which is getting hit by a plunge in crude oil prices, which fell below US$40 per barrel in New York trading on Friday for the first time in more than six years, but the selling has become more broad-based over the past few weeks, pushing up borrowing costs for companies across a wide range of industries.
Other measures of financial conditions show tightening as well. An index maintained by economists at Goldman Sachs Group Inc points to the tightest conditions since October 2011, in large part due to the recent surge in the value of the US dollar versus other currencies.
Versions compiled by regional Fed banks in Chicago, St Louis and Kansas City paint a more benign picture. These are updated less frequently than the Bloomberg and Goldman Sachs indexes and put less weight on the value of the dollar as a first-order input.
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