The Federal Reserve (Fed) faces a big challenge as it seeks to raise interest rates this year: The central bank already missed the “window of opportunity” for normalizing rates in a manner that doesn’t hamper the recovery.
This is evident when you take a close look at two charts depicting BlackRock’s proprietary Yellen Index, which tracks a suite of indicators that Fed Chair Janet Yellen has cited as being critical for Fed movement and that have coincided with historical Fed moves.
The Fed could have begun rate normalization as early as mid-2014, when the Yellen Index was displaying strong upward momentum, as evident in the charts above. The window for the Fed then lasted through December 2015. But since the start of this year, our index has turned downward, and its momentum has dropped further into negative territory.
This is partly a result of slowing U.S. payrolls growth, a clear trend in April’s weaker-than-expected jobs data. Labor market tightness, on the back of previously strong gains, and the softening of corporate revenues and profits have made it hard for the jobs market to continue its long stretch of historic strength. Looking forward, as payrolls tend to track corporate profits by about six months, I expect to see a continued weakening in jobs numbers as the year progresses.
The slowing-payroll dynamic places the Fed in a difficult position. It implies that rate hikes will occur at a much slower pace than market watchers had anticipated at the start of the year. Two rate hikes this year aren’t out of the question, but one hike is more likely, and a Fed that remains on hold remains a distinct possibility.
Of course, the Fed’s very recent caution has been warranted, given the first quarter’s market volatility and economic weakness as well as the ongoing risks to global financial stability, particularly out of China. But U.S. realized inflation, inflation expectations and inflation breakevens are poised to grind modestly higher, so the Fed will eventually have to reconsider the importance of price stability versus other more global factors. The bottom line: The Fed’s job will only get tougher from here.
Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Global Fixed Income and is a regular contributor to The Blog.