U.S. Fed: “to raise or not to raise?”

By Raz Koroh

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Just when practically everyone is resigned to the reality that Fed chair Janet Yellen is not going to raise U.S. interest rate for the foreseeable future, then out came report of a big gain in jobs in July 2016 and upgraded employment estimates for the previous two months.  The U.S. Labor Department’s report of additional 255,000 jobs in July easily topped the most optimistic analyst forecasts for an increase of 185,000.  This automatically boosted the hawkish camp argument of the Federal Reserve raising interest rate sometime this year.  Analysts cite strong non-farm data, causing U.S. shares to hit all-time highs, industrial commodities to rally, and bonds to fall.  However, the question remains if this really indicates that a turning point is finally here or there about, or is it more of the same false signals that we have become accustomed to?

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Here are several factors to consider.

China’s economy.  Across the Pacific Ocean, the United States’ main trading partner struggled in July with worse-than-expected trade performance.  Measured in U.S. dollars, China’s imports fell 12.5 per cent year-on-year as weaker global commodity prices and lacklustre domestic demand weighed on the value of purchases, larger than the average 7.0 per cent forecast decline.  Exports also fell in U.S. dollar terms, dropping 4.4 per cent compared to expectations of average 3.5 per cent forecast decline.  Even taking into account of the slide of the yuan against the dollar, measured in yuan China’s imports still fell by 5.7 per cent and exports rose only slightly by 2.9 per cent.  This indicates that there is all the more reason for the Chinese yuan to fall against the U.S. dollar as China’s authorities engage in competitive currency devaluation against its exporting rivals.

Income inequality.  This is possibly the main reason that has so much impact on domestic consumption level.  The rosy employment data simply masks the reality that most of the new gains in employment come from low-wage sectors such as the hospitality service industry as well as the civil service.  Too few of the increases arise from the technology industry where the pay scale is very much higher due to a situation of low supply not keeping up with high demand for qualified technology workers.  The resultant increase in income gap between the highly paid and the lowly paid inevitably indicates a lower than expected purchasing power of the vast majority of working Americans, which than translates into a lower than expected investor confidence in the growth of the economy generally.

In conclusion, a low interest rate environment has a better chance of addressing such factors, compared to a high interest environment.  This is so because a high interest rate without fail will attract fund inflows into the United States, a situation that will strengthen the U.S. dollar against other rival major currencies.

Comments welcomed.