The recent decision by the Federal Open Market Committee (FOMC) to leave interest rates unchanged flummoxed many analysts and investors alike. Even more puzzling was the decision to change the expectation from four rate hikes to only two for the balance of 2016. Core inflation is the Fed’s driver for continuing its gradual glide path for normalizing rates, and it has stated that it wants to see inflation at the 2% range before raising rates again. It is. Core Inflation in February rose to 2.3% on an annual basis. As one writer punned in MarketWatch, core inflation causes many of us angst, since it strips out the costs of food and energy. But most readers will attest that food has soared, and although energy is well below the highs of recent years, oil prices have risen more than 38% off their February 11 low, and drivers are paying higher prices at the pump.
Even without food and energy in the equation, most people agree that prices are rising—and doing so much more rapidly than a Core Inflation year-over-year rate of 2.3% suggests. My own anecdotal evidence: medical premiums rose 18%, dry cleaning climbed 12%, my cell phone bill spiked 16%, and professional dues went up 10% in the last 6 months alone. To be fair, dues at my private club were raised a mere 3%, but it was still more than the core inflation rate.
The Fed’s theory is that declining unemployment will eventually cause wages to rise and propel consumers to spend. That’s what’s supposed to happen in a robust economy. But, it hasn’t played out that way—at least not yet. First, much ink has been expended on the real unemployment picture. The labor participation rate has hovered around 63% since 2012 (it was over 66% in 2006, prior to the Great Recession). Another piece of anecdotal evidence: a colleague who has been consulting in financial services marketing for five years (while looking for a full-time gig) was just told that the position he applied for, and for which his stellar credentials qualify him, isn’t going to him: The company wants to hire someone who is already employed. That is why my colleague, and countless others who’d like to be working, can’t find a job. Will further declines in unemployment change that picture?
So, if the Fed’s decision hinges on inflation (which already is above 2%), then there must be another reason for holding off on normalizing interest rates. Could it be that the economy is still sputtering? The devil is in the details—and the data. Retail sales were off by -.1%, on the back of a -4% drop in January, which was revised downward from a positive .2%.
The Fed had plenty of data to act. They should have. One economist friend, responding to the question of whether the Fed would make a move, quipped, “The idiots should, but they won’t.”