Will the US increase the Fed funds rate? By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

August 11, 2016 | Posted by bobbysrinivasan << back to blog

The news came that the US employers hired more workers than expected for the second straight month thus providing the necessary ammunition to the Fed Chairman Janet Yellen to consider pushing up the Fed funds rate by 25 basis points in the next open market committee meeting in the month of September. This is a conversation between a student and his Professor.

Student: The July pay roll growth was expected to be around 180000. Surprise, the number turned out to be 255000. The June figure was also revised upward to 292000. The unemployment rate seems to remain 4.9%. Is it time for the next hike in the Fed funds rate.

Professor: Possibly. There is one more job data due in September before the interest rate revision decision is taken. The most encouraging part is the job participation rate which has moved to 63.3% from 62.7%. This implies more jobs are there and the present unemployed are becoming hopeful. But having said nice things about job creation the GDP growth rate for quarter 2 turned out to be 1.2%. The market was expecting 2.6%. For the quarter 1, it was revised down from 1.2% to 0.9%. The average hourly wages increased by 2.6%. One possibility is since the US Fed election is due on Nov 8, 2016 the Fed may decide wait and push up the interest rate in the December open market committee meeting.

Student: Currently the Fed funds rate is at 0.25% and moving to 0.5%. Is it any big deal?

Professor: If you knew the US fed history. You will be amazed at what is happening there. In 1980 when Paul Volcker was the Fed Chief, the Fed rate stood at 20% with an unemployment exceeding 12.5%. This shows as to how much the interest rate has come down. Combined with a 4 trillion dollar quantitative easing it is really mind boggling.

Student: Is the Fed seeing economic recovery in the future?

Professor: The entire world is vulnerable to deflation. Japan is virtually buried in deflation. Poor job creation, QE failing to deliver. PM Abe is keen on the inflation rate to move up to 2% but it is not happening. Brexit has guaranteed that Britain will go into a serious recession. The anemic economic growth in Europe is again deeply discouraging. It appears as though that they might never come out of recession. The recently announced massive drop in Chinese exports warns us of a slow economic growth. One thing is certain. The US dollar will continue to strengthen against all its major trading partners. The price of gold is now poised to run up; given the stock markets are remaining stagnant. For India it is a different story. I feel that GST when introduced will lead to an economic slowdown and the Indian savings rate will drop significantly. Any way Buy dollar sell Rupee in the futures market at the appropriate time. You will be a winner.

Student: Thank you, Professor.

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