Strong US, weak world picture challenges Federal Reserve

Markets will focus on how optimistic the Federal Open Market Committee is in its policy statement at the end of the two-day meeting on Wednesday. Federal Reserve Chair Janet Yellen will also discuss the situation with journalists after the meeting and present new economic forecasts from the panel. An improved outlook is not certain. The Fed is caught between crosscurrents and needs to wait to see how those develop. – Reuters pic, March 13, 2016. ​Federal Reserve policymakers will hold their finger away from the rate-hike trigger when they meet next week, analysts say, but chances are it could move a bit closer.

Meeting after the European Central Bank cut interest rates Thursday in the face of weakening eurozone economic growth and inflation, the Fed is expected to heed caution even as it sees good signs of strength in the US economy.

Those signs though, analysts say, increasingly point to June – or possibly even April – for the next increase in the federal funds rate, the Fed's short-term benchmark, after December's hike to 0.25-0.50%.

"Given faster-than-expected job growth in February coupled with another quarter of disappointingly slow productivity growth in Q4, the case for tightening is arguably stronger now than in December," said an analysis by economists at FTN Financial.

Markets will focus on how optimistic the Federal Open Market Committee (FOMC) is in its policy statement at the end of the two-day meeting on Wednesday.

Fed Chair Janet Yellen will also discuss the situation with journalists after the meeting and present new economic forecasts from the panel.

An improved outlook is not certain. The Fed is caught between crosscurrents and needs to wait to see how those develop.

One is the strength of the US economy. Job creation and consumer spending both remain strong and promise to keep driving domestic activity, after a winter slowdown.

Inflation though is still very weak. But Fed Vice Chair Stanley Fischer said on Monday that he expects the negative drag on growth and inflation from the collapse of the oil market to disappear as oil prices bottom out.

After that, the economy will see more clearly the result of strong job gains and consumer pocketbooks fattened by cheap gasoline prices, he said. And that could justify higher interest rates.

But the other current is the slowdown in growth in the rest of the world. Recent dire warnings by the International Monetary Fund over this counsel the Fed to be cautious about tightening policy.

IMF Deputy Managing Director David Lipton said that there is an increasingly "dangerous" view that policymakers worldwide have exhausted their options for boosting growth or have simply lost their will.

In recent months, he said, "risks have increased further, with volatile financial markets and low commodity prices creating fresh concerns about the health of the global economy."

He called on central banks to keep monetary policy loose and governments to spend more to boost growth.

That view was reflected in recent speeches by Fed governor and FOMC member Lael Brainard, who has focused on the volatility in global markets and weak emerging market economies as signals the Fed should hold off and not risk more damage.

"Given weak and decelerating foreign demand, it is critical to carefully protect and preserve the progress we have made here at home through prudent adjustments to the policy path," she said on Monday.

Fischer though said he sees inflation picking up soon, suggesting he could be biased towards tightening policy sooner to prevent price gains from getting ahead of the central bank.

"We may well at present be seeing the first stirrings of an increase in the inflation rate – something that we would like to happen," he said.

Jim O'Sullivan, chief US economist at High Frequency Economics, said he expects the FOMC to be relatively positive about the future path of the economy.

"We expect officials will continue to project much more tightening ahead than is being priced into fixed-income markets," he said.

Based on CME fed fund futures, the market prices sees only one quarter-point increase in the fed funds rate this year.  – AFP, March 13, 2016.