December will mark the seventh year in which the Fed has kept interest rates near zero. But if Christine Lagarde and the IMF have their way, zero interest rate policy in America will last at least into year eight.
The IMF released its annual report on the U.S. economy on Thursday, lowering its forecast for growth in the U.S. to 2.5% in 2015–down from 3.1%–and urging Janet Yellen and the Federal Reserve to hold off on raising interest rates until at least the new year. According to a statement released by the IMF:
The FOMC should remain data dependent and defer its first increase in policy rates until there are greater signs of wage or price inflation than are currently evident. Based on the mission’s macroeconomic forecast, and barring upside surprises to growth and inflation, this would put lift-off into the first half of 2016.
The news came amid a generally volatile day for markets. On Wednesday, bond yields in both the U.S. and Germany reached highs on the year, which likely helped trigger a selloff in equity markets Thursday. But yields on the 10-year Treasury fell after the announcement from the IMF, suggesting that traders might believe that the IMF statement signals a shifting of attitudes on the likelihood of a September interest rate hike.
“It matters only if the Fed listens to the IMF. Ultimately, it comes down to the economic data and a lot can change between now and September,” Randy Frederick, managing director of trading and derivatives for Charles Schwab in Austin, Texas, told Reuters.
The logic against raising rates, as the IMF and others have outlined, is that inflation remains tame and that economic growth is still below potential. With no signs of creeping inflation, it doesn’t hurt for the Fed to keep the pedal on the monetary metal, while removing stimulus too early could risk forcing interest rates and the dollar unnecessarily higher, putting a damper on the recovery.
But Fed officials appear to be ready to raise rates this year nonetheless. In a recent speech to the Providence Chamber of Commerce, Fed Chair Janet Yellen said, “I think it will be appropriate at some point this year to take the initial step to raise the federal-funds rate target and begin the process of normalizing monetary policy.”
The argument for raising rates is that it would help increase financial market stability by putting a damper on investors “reach for yield,” which can be seen everywhere from a bubbly tech sector to plentiful financing for oil exploration companies even as oil prices remain depressed.
Raising rates would also give the Fed room to stimulate the economy if we face another downturn. Meanwhile, there’s little evidence that low rates are actually boosting the sort of corporate investment that would help stimulate faster growth, though there is plenty of evidence that firms are using cheap money to buy back their own stock.
At the same time, the main transmission mechanism for monetary policy, the housing market, is showing renewed signs of life. Household formations are up, and more new residential real estate projects began in March, on an annualized rate, than at any time since 2007. Low rates keep demand for housing high, since lower mortgage rates can make real estate dramatically less expensive.
The Fed will surely take the IMF’s opinion into consideration, but data on the housing and jobs markets will be the main driver of the Fed’s decisions between now and the end of the year.