Why you shouldn't expect rates to head upward for a while

Several forces have weighed on U.S. and global inflation for years and appear unlikely to reverse soon.

  • By Paul Kiernan,
  • The Wall Street Journal
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Federal Reserve Chairman Jerome Powell recently set a high bar for raising interest rates, one that looks unlikely to be met for a long while.

“We would need to see a really significant move-up in inflation that’s persistent before we would consider raising rates,” Mr. Powell said at a press conference in October.

Even without a precise definition of significant or persistent, this standard appears out of reach through at least next year, given recent inflation trends and the Fed’s shifting understanding of the economy.

Fed officials raised rates four times last year largely because they expected solid U.S. economic growth and falling unemployment to lift inflation above their 2% target or higher, after it fell short for most of the past decade. They also thought their benchmark rate, even after those increases, was still low enough to drive faster price gains.

But they reversed course this year, cutting rates three times due to slowing global growth and trade uncertainty.

In a speech last week, Mr. Powell also justified the rate reductions by saying the U.S. economy had less momentum last year than Fed officials thought. He also said the Fed’s benchmark interest rate—currently in a range between 1.5% and 1.75%—was providing less support to the economy last year than policy makers thought and even now isn’t very stimulative.

Moreover, several forces have weighed on U.S. and global inflation for years and appear unlikely to reverse soon. These include China’s economic slowdown, aging populations, globalization and technological advances.

Annual U.S. inflation has been running below 2% for most of the past decade and was just 1.3% in October, according to the Fed’s preferred gauge. Core inflation, which excludes volatile food and energy prices, was 1.59% in October.

Mr. Powell and other officials have indicated they would be willing to let inflation exceed 2% for a time to convince people their target isn’t a ceiling.

“The threshold to cut rates is still significantly lower than the threshold to raise rates,” said Diane Swonk, chief economist at Grant Thornton. She said core inflation would probably have to hit 2.25% for six months or so for the Fed to consider lifting rates.

But the last time that happened was in 2008, when circumstances were very different.

Back then, global inflation was climbing as China’s economy grew up to 12% a year, almost twice its current pace, boosting demand for raw materials needed to build new infrastructure and feed an expanding middle class. Between 2003 and 2008, global prices for copper and crude oil quintupled, prices for iron ore quadrupled, and prices for soybeans and corn more than doubled.

The effects of the commodity boom rippled through the U.S. economy. Gasoline and some food prices rose sharply, but so did prices for services including shipping, utilities and air travel. Housing prices surged amid a bubble in subprime lending, while health-care prices climbed about twice as fast as they have risen in the current expansion.

Few of those phenomena appear likely to repeat themselves—individually or in unison—in the foreseeable future.

China’s leaders are reluctant to provide stimulus because they believe a cooling economy is inevitable and even necessary to curb rising debt levels.

While droughts or hurricanes may cause occasional price spikes for some goods, a synchronized surge across commodity markets could require another large nation to repeat China’s boom—something that has few historical precedents.

Core U.S. inflation hasn’t significantly exceeded 2% in the absence of a major rise in commodity prices since the mid-1990s.

Meanwhile, new technologies have enabled the extraction of oil and gas from shale or deep-sea reservoirs that were either unknown or unreachable just a decade ago. U.S. oil production has more than doubled in the past 10 years, reducing the ability of the Organization of the Petroleum Exporting Countries to prop up prices—a recurring catalyst for inflation since the 1970s.

When global oil prices spiked in late 2017 and early 2018, U.S. shale drillers quickly increased output, causing prices to fall back. Broader U.S. inflation followed suit, slowing to 1.31% in February 2019 from 2.45% in July 2018.

Also keeping inflation in check are technologies enabling consumers to comparison shop online, older people who buy fewer goods and services and a globally integrated economy that makes many prices less sensitive to domestic factors like changes in wages or productive capacity.

With inflation weak and economic growth slower this year than last, many forecasters have lowered their expectations for Fed rate increases.

“Our forecast is that the Fed’s on hold, really, for the foreseeable future,” said Brett Ryan, a senior U.S. economist at Deutsche Bank.

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