Oliver Mangan: US interest rates may rise more quickly than many think
Inflationary pressures are building in the US along with continuing robust economic growth which suggests policy tightening could be coming before too long.
The US does not look like an economy where official interest rates should be pitched at virtually zero.
The labour market appears to be tightening rapidly, with close to one million jobs added in each of the last two months and the unemployment rate dropping to 5.4% in July from 5.8% in June.
And strong jobs growth is expected to continue in the coming months also. Unfilled job openings rose by 590,000 to a seasonally adjusted 10.1 million in June, the highest level since record-keeping began in 2000. This is greater than the number of unemployed persons, which stood at 8.7 million in July.
Meantime, the economy is growing strongly, and output is back to its pre-pandemic levels. Real final GDP sales rose by over 9% and 7.7% on an annualised basis in the first and second quarters of the year, respectively. ,
Strong survey data for July point to continuing robust economic growth as we move into the second half of the year.
Meanwhile, inflationary pressures are building. Average hourly earnings of workers rose by 0.4% in both June and July, with the year-on-year rate standing at 4%.
The core rate of consumer price index, which excludes food and energy, stood at 4.3% in July, with the headline rate running above 5% in recent months.
It is the strong view of the US Federal Reserve that the upsurge in inflation this year is due to temporary factors that will abate, and expects inflation to drop back to around its 2% target by the end of next year.
Fed officials have been saying for the past year that they would maintain the current very loose stance of monetary policy, comprising of near-zero interest rates and bond purchases of $120bn a month, until there is "substantial further progress" toward meeting the central bank's goals for inflation and employment.
Over the past week, however, there have been soundings from several top Fed policymakers that the inflation goal has been achieved and that another couple of months of strong jobs growth could see its’ employment goal accomplished also.
This suggests that policy tightening could be coming before too long. We would not be surprised to see the Fed start to taper, or scale back its asset purchases, in the final quarter of the year. The Fed will likely provide clarity on its intentions in this regard in the coming weeks.
This would pave the way for interest rate hikes somewhat further down the line. The market view, as evidenced in futures contracts, is that the first Fed rate increase will be in December 2022, with the funds rate being hiked to 0.25% from 0.125%. Rates are seen as rising by a further 50 basis points in 2023, taking them up to 0.75%.
One has to wonder if the Fed will be this patient, especially if the labour market continues to tighten rapidly and inflation proves anyway sticky in 2022 and remains comfortably above 2%. It is a long time to December 2022 to wait for a meagre interest rate hike, notwithstanding the continuing uncertainty around the course of Covid-19 in the US due to high levels of vaccine hesitancy.
A close eye should be kept on the Fed in the coming weeks as markets will need to come to terms with a likely shift in policy, which may come earlier than they had anticipated.
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