The Federal Reserve (Fed) faces a big challenge as it seeks to raise interest rates this year: The central bank already missed the “window of opportunity” for normalizing rates in a manner that doesn’t hamper the recovery.
This is evident when you take a close look at two charts depicting BlackRock’s proprietary Yellen Index, which tracks a suite of indicators that Fed Chair Janet Yellen has cited as being critical for Fed movement and that have coincided with historical Fed moves.
The Fed could have begun rate normalization as early as mid-2014, when the Yellen Index was displaying strong upward momentum, as evident in the charts above. The window for the Fed then lasted through December 2015. But since the start of this year, our index has turned downward, and its momentum has dropped further into negative territory.
This is partly a result of slowing U.S. payrolls growth, a clear trend in April’s weaker-than-expected jobs data. Labor market tightness, on the back of previously strong gains, and the softening of corporate revenues and profits have made it hard for the jobs market to continue its long stretch of historic strength. Looking forward, as payrolls tend to track corporate profits by about six months, I expect to see a continued weakening in jobs numbers as the year progresses.
The slowing-payroll dynamic places the Fed in a difficult position. It implies that rate hikes will occur at a much slower pace than market watchers had anticipated at the start of the year. Two rate hikes this year aren’t out of the question, but one hike is more likely, and a Fed that remains on hold remains a distinct possibility.
Of course, the Fed’s very recent caution has been warranted, given the first quarter’s market volatility and economic weakness as well as the ongoing risks to global financial stability, particularly out of China. But U.S. realized inflation, inflation expectations and inflation breakevens are poised to grind modestly higher, so the Fed will eventually have to reconsider the importance of price stability versus other more global factors. The bottom line: The Fed’s job will only get tougher from here.
About the Author: Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Global Fixed Income and is a regular contributor to The BlackRock Blog.This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of May 2016 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking" information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. ©2016 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners. USR-9277
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