Q1's GDP Will Likely Delay Interest Rate Increase Beyond June

The Federal Reserve Bank in Washington DC

WASHINGTON, DC—The economic calendar was not kind to the Federal Reserve Bank’s Federal Open Market Committee this month.  The policy-making organization was scheduled to release its statement about its decision, or non-decision, on interest rates the day before the US Bureau of Economic Analysis was set to release its first pass at the first quarter’s gross domestic product. To be sure, expectations were low for Q1′s economic output. But the Fed has been under pressure to come up with a set path to monetary policy to which it could stick. Hinting that it may notch up the federal funds rate in June, which it did in Wednesday statement, would not be a good move if the GDP figures, released on Thursday, were worse than expected. Which they were. BEA reported that GDP increased at an annual rate of 0.5% in the first quarter of 2016, an “advance” estimate that will be followed by revisions in the coming weeks.  The second reading of Q1′s GDP will be released on May 27 ^th . It was a marked slowdown from the Q4′s growth rate of 1.4% and lower than the estimates of economists surveyed separately by Reuters and The Wall Street Journal. In both surveys economists had predicted a 0.7% annual rate increase for the quarter. A cutback in in businesses investing in new equipment was one of the main drags on growth — it was, in fact, the sharpest drop in capital outlays since the second quarter of 2009 — along with a slowdown in federal government spending and a strong US dollar. The falling business outlays reported in the GDP figures should have come as no surprise to anyone paying attention. Two days prior to their release, the Washington DC-based association, the Equipment Leasing and Finance Association, which does its own survey of this activity, reported that year-to-date, cumulative new business volume had decreased 9% compared to 2015.

Chief Economist Heidi Learner

June or When, Exactly? And so the never-ending guessing game about what-will-the-Fed-do continues. It released its statement the day before the GDP figures were released but it almost surely had a good sense of what they would say. Does that mean the Fed really will restart its campaign of nudging up the federal funds rate again despite the dragging growth? Or will it pull back once again? In its FOMC statement , the Fed itself seems to be saying that while conditions are not quite right at this point in time for a tighter monetary policy, they will be shortly.

Information received since the Federal Open Market Committee met in March indicates that labor market conditions have improved further even as growth in economic activity appears to have slowed. Growth in household spending has moderated, although households’ real income has risen at a solid rate and consumer sentiment remains high.

Reading between the lines, many have decided that the Fed was “hinting” that a rate increase could happen the next time it meets, which will be in June.  Others believe that the Fed may be considering it, but a June increase is highly unlikely. “If I had to guess it is probably a little too early for an increase in June,” Savills Studley’s Chief Economist Heidi Learner told GlobeSt.com before the GDP figures were released and after the FOMC statement was made public. It is widely expected that the Q1 GDP will be weak, she continued. “I don’t think there will be enough economic data for the Fed to access to make a decision about rates in June. The data we have now, in April, about Q2, doesn’t indicate that Q2 is starting off particularly strong.” A rate increase in June is within the realm of possibility, Learner said, but it more than likely will happen later in the year. A Self-Perpetuating Cycle for the Fed and Banks The irony is, by standing still on its monetary policy the Fed is fueling uncertainty among investors and lenders, who in turn may scale back lending to wait out of the Fed. A blog post by Susan Persin, Senior Director of Research at Trepp, pointed out that after the Fed’s announcement stocks for the largest banks, including JP Morgan Chase, Bank of America, Wells Fargo  and Citigroup all dipped noticeably.  She wrote:

Higher interest rates are usually a positive for banks, because they can then raise interest rates on loans faster than they increase interest paid on deposits. Higher rates would create the possibility for greater profitability, especially at a time when banks are facing pressure from loans tied to the oil and gas industries.

Persin as well pinpoints September as the more likely date for the Fed to try again with the federal funds rate. Businesses Wait for the Fed Too It is not just banks that are waiting for the Fed to make a definite move. One reason businesses have been holding off on capital expenditures is the uncertainty around interest rates, according to Tony Golobic, CEO of GreatAmerica Financial Services, speaking on behalf of ELFA.  After all, there is ample supply of capital and ELFA also reported an increase in credit appetites by some in the industry. But, he said:

Uncertainty about the Fed’s thinking about interest rates, the election, and the Great Recession resonates with many. These factors are resulting in some reluctance to invest in new equipment.