Delaying rate increase: A mistake of the Fed?

After the US central bank has increased interest rates for the first time in nine years, further rate raises during the year have been postponed. With increasing inflation, this might require more aggressive intervention, says ETF Securities.

The US economic growth is stable and there are no signs of a slow down. A tighter monetary policy is required says Martin Arnold, Director and FX & Macro Strategist at ETF Securities. The Fed seems to look more at the increasing prices for financial assets and reacts on other external factors that are not part of their mandate to ensure full employment and price stability.

A first mistake of the Fed is to concentrate on asset prices. As long as those are not influencing inflation or expectations, the Fed should not consider them, says the previous president of the US central bank, Ben Bernanke. Instead of just reacting to market developments if the financial stability is in danger, the Fed is adjusting to the dictate of the markets, says ETF Securities in their recently published outlook.

Despite the Fed expecting an inflation of 1.6 percent, ETF Securities expects that inflation might be above the Fed’s goal of 2.0 percent. One trigger for higher inflation is the strong employment market. With just 4.7 percent, employment is at the lower end of the long-term trend. If inflation increases, households will demand nominal wage raises that could trigger a wage-price spiral.

Due to the strong employment market, the Fed should concentrate more on the price level and inflationary pressure. If the Fed reacts to slow, inflationary expectations could become more dynamic and the Fed must react more aggressively. If the Fed remains to be cautious about increasing interest rates, the credibility of the Federal Reserve is at stake, says Arnold in his outlook