Markets & Economy
Waiting for the Fed
July 18, 2014
Catherine Gordon: Everyone is wondering when the Fed will start raising U.S. interest rates. Roger and Joe, what is the Fed watching most closely as it ponders its decision, and what's Vanguard's outlook on short-term rates and when you think they'll start to move?
Joe Davis: Well clearly, the Federal Reserve is focusing on the vigor and strength in the labor market and related to that is how tight the labor market is as represented by the unemployment rate. And then conversely, they're also looking at inflation, which we've seen arise recently, not just in food and energy prices but other prices for certain goods and services. So I think critically for the Fed is really three questions, Catherine—it's when they may lift off, it is how quickly and how aggressively they will raise rates, and then finally when will they end rates [changing], in other words, at what level, currently close to zero.
In our view, the Federal Reserve will very likely raise rates next year. That is similar to the expectations in the fixed income market. And we continue to believe that the Federal Reserve . . . that this will be a multiyear process of raising rates, and ultimately they may even pause after several meetings of tightenings, perhaps at 1%, to reassess how vigorous the economy can withstand higher interest rates.
And so ultimately, we're hard-pressed to see a rapid rise in short-term interest rates, in large part, because the economy's just not at this point displaying the sort of strength that you would like to see. I think the one wild card that we could see, which not only we are closely watching but the Federal Reserve is closely watching, would be signs of wage pressures and wage growth, because that not only would suggest potentially—[although] we're not seeing it now—it would suggest that not only the economy can grow more aggressively, say in 2015 and 2016, but also that [it] could be a canary in a coal mine, so to speak, of broader inflation pressures. So we're not going to see that yet, but it's something that we could see a little bit more in 2015.
Roger Aliaga-Díaz: There are some opinions that the Fed could take longer to start increasing rates, but in our view, as Joe was saying, the hurdle to increase rates is not that high in the sense that unemployment and other metrics are getting in the zone of that target, that the Fed may have. And ultimately the Fed may start or may need to raise rates even before they actually hit the target in a preemptive way, and also to test many of the tools that they are bringing . . . new tools that they are going to implement [in] this exit strategy. So to your point Joe, which is great, is there may be even a pause in which the Fed will reassess and to see how those tools are working, because they are new tools that they're being used in order to tighten and that clearly could happen next year or further still.
Catherine Gordon: Right. Thank you.
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Two Vanguard economists discuss monetary policy
In a short video, Chief Economist Joe Davis and Senior Economist Roger Aliaga-Díaz give their thoughts on when the Federal Reserve might start to raise short-term interest rates.
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- All investing is subject to risk, including the possible loss of the money you invest.