3Q CENTRAL BANKING: The Fed Still on Pause for Raising Rates

 
   By Jon Hilsenrath 
 

        Many Federal Reserve officials began the year thinking they would raise short-term interest rates by midyear. That point has come and gone with no move, and now officials are looking toward a rate increase in the third or fourth quarter.
        What will it take to get them to pull the trigger? The Fed has set up two tests: continued improvement in the labor market and confidence that inflation will start moving toward 2% after running below it for more than three years.
        A September move is now shaping up as a close call. Fed Governor Jerome Powell put the odds of a September move at 50/50 in an interview with The Wall Street Journal in June. Traders in futures markets put the probability even lower. They agree on one point: "I don't think the odds are 100%," Mr. Powell said.
        The jobless rate, at 5.3% in June, is just outside the 5% to 5.2% range where Fed officials believe it can settle in the long run without spurring inflation. Many officials see reduced slack in the labor market as a key condition for developing confidence that inflation will return to 2%.
        The Fed will have two more jobs reports to observe before its Sep. 16-17 policy meeting. The unemployment rate could well be at its long-run level by then, a move that would give officials a stronger incentive to act.
        Though they are watching a wide range of labor market indicators, they still see the jobless rate as the best overall indicator of labor-market slack. Their confidence in the labor market is underscored by the fact that employer payrolls have expanded for a record 57 straight months.
        Adding to their incentive to move are nagging worries that a prolonged period of very low interest rates could spur financial excesses that will harm the economy later. The Fed begins the third quarter needing to take measure of a growing, debt-fueled mergers-and-acquisitions boom gripping Wall Street and a commercial real estate boom. Officials have said they don't want to use interest rates increases to prick financial bubbles, but if these or other financial booms grow, the temptation to address them will build.
        The central bank also will see plenty of reasons to hold off. Most notably, there are no signs of inflation hitting the economy. In May, the consumer price index was flat compared with a year earlier and the personal consumption expenditures price index--the Fed's preferred consumer inflation measure--was up just 0.2% from a year earlier. Last year's plunge in oil prices had a lot to do with that. But inflation trends are dormant excluding food and energy. The core personal consumption expenditure price index--which extracts food and energy and is another measure the Fed watches closely--has decelerated in the past year, from 1.5% year-on-year gains in the middle of last year to a 1.2% year-on-year gain in May.
        New worries about Greece's debt default and China's economic slowdown could also freeze the Fed. Adding to those concerns are other looming threats--including the risk of a new battle between Congress and the White House about raising the federal debt ceiling in the second half of the year.
        For Fed Chairwoman Janet Yellen, the tough looming choices will mark another test of her leadership, her will and her wisdom. The world will be watching.
        --Write to Jon Hilsenrath at jon.hilsenrath@wsj.com
        (END) Dow Jones Newswires

        July 08, 2015 05:59 ET (09:59 GMT)

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