The Fed’s decision to raise rates will remain data dependent, and liftoff will be delayed if the economic and inflation data continue to underwhelm the Fed’s expectations.
Our U.S. fixed income team recently compared the economic data today with prior Fed liftoff cycles. A few observations stand out:
- Current GDP growth is below the level that preceded previous Fed liftoffs, especially in nominal terms;
- Headline inflation is also far lower than in past liftoff cycles, although core PCE inflation is at the same levels seen five months before the 1999 and 2004 Fed liftoffs;
- Unemployment is close to the levels that prevailed in the run-up to the 1997 and 2004 initial Fed rate hikes, although the growth in labor productivity is well below that of all past cycles;
- Among conventional measures of economic slack, the output gap is close to the levels of the 1994, 1997 and 2004 liftoffs, while the unemployment gap (U-3 minus NAIRU) was only lower prior to the 1999 Fed liftoff.
Judging by history alone, a Fed liftoff in September 2015 appears pre-emptive with regard to current growth and inflation rates, but far less so when looking at measures of excess slack in the economy. The Fed has downgraded the importance of the latter, especially given that structural trends make it particularly difficult to gauge slack this cycle.