Richard Cox

About the Author Richard Cox

Richard Cox is a university teacher in international trade and finance. Lecture halls of 80 to 120 students. Lessons in macroeconomics and price behavior in equity markets. Investing strategies in these articles are based on technical and fundamental analysis of all the major asset classes (stocks, commodities, currencies). Trade ideas are generally based on time horizons of one to six months.

Economic Outlook: Federal Reserve Likely To Proceed With Caution

The US Federal Reserve is, at the moment, cautiously optimistic about its national economy. But when we look more deeply into the international context that is likely to influence overall GDP performance, the situation is more worrisome. The minutes of the June 15, 2016, FOMC meeting are quite revealing of the uncertainty felt by the Federal Reserve about both the domestic and international economy, and these are factors that are likely to impact the financial markets over the next few months.

Policy Reactions To The Data

In a policy speech she made last month, Fed Chairman Janet Yellen suggested that the growth performance in the US has shown consistent signs of improvement and strength. Gains in the job market might not be as strong as the Fed originally hoped – but job growth seems to be there to stay. “In particular, the job market has strengthened substantially, and I believe we are now close to eliminating the slack that has weighed on the labor market since the recession,” Yellen said.

Chart Source:

Recent US data show that total non-farm payroll employment increased by 287,000 in June, and the unemployment rate dropped to 4.9 percent. In the chart above, the recessionary period is marked by the cross-hatched areas in 2008-2009. Overall, we can see that the picture continues to look encouraging. But many analysts have argued that the numbers posted in June should not hide the dismal jobs growth report released in May as its underlying implications about slowing job growth could create more headwinds in the financial markets during the summer months.

According to a report co-written by Michael Madowitz and Juliana Vigoritofrom the Center of American Progress, this sudden job growth in June should not be seen as a real victory. According to Madowitz, “even reaching an agreement on what the latest labor market data mean is proving a challenge for those in power and sideline pundits alike. Madowitz goes on to say that “if the economy is merely leveling out after a period of strong growth, that may signify a strong economy with near-full employment. The alternative perspective suggests that labor force participation is slumping and clouding the real meaning of recent unemployment rate numbers.”

The Federal Reserve is pondering over those economic indicators to see whether they are going to be able hike interest rates in July – or to leave potential policy changes on hold for now. The weak jobs report in May 2016 has already created a marked change in the ways voting policymakers at the Fed have phrased their responses to questions in the financial media. It is true that the better labor market numbers could make the Federal Reserve reconsider its interest rate policy. But it is important to remember that there are points of opposition here that could start to gain acceptance.

Oppositional Arguments

A recent editorial by the New York Times suggests that keeping interest rates low would be the smartest move in an era of uncertainty. According to the New York Times, the job growth seen in June is somewhat reassuring but the overall numbers for the past quarter are not as good as they should be. This means that it is unlikely that labor markets will be able to sufficiently support rising wages and increased consumer spending. On top of this, we must remember the fact that interest rates are not the only question the Federal Reserve faces: inflation also is high on the agenda.

“While the economy has made great strides toward the FOMC’s objective of maximum employment, somewhat less progress has been made toward our inflation objective,” said Yellen in her comments. The target inflation rate of 2% is still far from being attained – further evidence that the past few years have shown a somewhat bumpy recovery.

But before the Federal Reserve can start to raise rates as previously planned, the central bank will need to achieve a clearer assessment of the international economic picture, notably the Brexit consequences – which are still being felt across markets around the world – as well as uncertainties about oil prices.

Continued Brexit Consequences

The Brexit – the referendum in which UK voters, somewhat unexpectedly, voted to opt out of the European Union – plays a role in how markets react at the moment as they closely follow the events unfolding in the UK. And given the interconnected nature of the US and UK economies, it is clear that we will need to wait for the dust to settle before we have a realistic idea of what to expect.

In a press release dated June 24, 2016, the Federal Reserve said it is “carefully monitoring developments in global financial markets.” But since we cannot yet be sure is sure about how the Brexit is going to play out – and to what extent markets could be adversely impacted – any projections at this stage will be premature.

External Markets In Oil

Chart Source: EasyMarkets

Raising interest rates in these conditions could be the wrong move for the Federal Reserve as this would add unexpected pressure on the US economy. And uncertainty about oil prices will only exacerbate these factors going forward. Oil prices have seen a rebound since they reached a very low point at the beginning of 2016. However, this rebound could be seen as a new bubble where oil prices are going to peak before starting another new rapid downfall.

These types of ups-and-downs in oil markets adversely affect the US national economy as a significant oil importing country. But demand for oil in emerging markets countries might help the oil industry keep in good shape and not affect the US economy, allowing, in turn, the US federal reserve to raise its interest rates in the coming months. The best indicator of this will be seen if oil prices can break critical psychological resistance at the $50 mark but at the moment this looks unlikely. The first level to overcome is seen in the chart above at $46, which is now a double-top formation that could halt prices going forward. All of the added uncertainty here will keep the Fed on hold for the time being.