Williams said the slide in the oil price, falling inflation expectations, and temporary bursts of consumer price deflation are a ‘double-edged sword’ for economies around the world which leaves central banks hoping to start normalising interest rates this year having to seek non-inflation reasons, which will be difficult to find.
The US is an exception to this in Williams’ view however. US real GDP is 10% up on its pre-crisis peak, and the dual mandate incorporating employment growth offers ‘scope later this summer for their first rate hike since June 2006.’
Hermes has quantified the trade-off between the US’s 2008-09 rate cuts and its QE, to gauge how excessively loose US policy has become. Adjusting for QE in this way, Hermes said the US is running a de facto Fed funds rate of about -5%, or as little as -7% in real terms.
“The FOMC will thus want to get the ‘normalisation ball’ rolling,” Williams said. “Its steps will admittedly be nuanced and small, using incrementally more hawkish language before a first, 25bp hike possibly around its new economic forecast in September.”
“But, even this will be ‘sugar coated’ by reassurance that the pace of normalisation will be slow and data dependent. On the basis of the US’s relative insulation from global economic headwinds, the fall of unemployment into the Fed’s 5.00-5.5% ‘Nairu’ range and our upbeat growth outlook, more should follow,” he added.
