In our interest rate video you have seen why the Fed, the US central bank, has raised interest rates. We also updated you on the central bank's plan to make borrowing more expensive twice more over the course of this year. However, we must bear in mind that the bank will not be able to do that.
If the American economy is really doing well and the prospects are rosy, as the Fed says, then it is quite strange that the Fed wants to raise interest rates 'only' 3 times this year. The official interest rate then amounts to 1,5 percent. By all standards, this is too low a level in a prosperous economy. The bank must then increase the interest rate much faster.
This brings us to a second reason to refute the Fed's position. We have to take into account that the bank will only raise the official interest rate once this year. The American economy is in much less good shape than the Fed would have us believe.
Influence of President Trump
It is true that confidence among consumers and in businesses has increased considerably in recent months. However, such a headline figure obscures the most important details. For example, consumer confidence has risen enormously since President Trump's victory, but this is especially the case among his supporters. Research shows that trust outside that group is actually under pressure.
We also see this effect in the many new jobs each month. A striking number of new jobs have been created in construction. That sector has traditionally been dominated by Republican supporters. The fact that 'their party' had achieved a tremendous election win boosted confidence. Based on that good feeling, they have hired many new people. The latter is also related to the assumption that the construction sector will benefit significantly from President Trump's plans, such as building new infrastructure and improving the current infrastructure.
Purchasing power shows dark clouds
If we look at the changes in purchasing power among American residents, some dark clouds can also be seen. Wages may have risen a bit more recently, but inflation has also risen sharply. Collectively, this means that the purchasing power of workers in the US has, at best, not increased and has often even fallen slightly due to increased inflation.
Economic growth continues to decline
Economic growth in the last quarter of last year was 1,9 percent, but that was the second estimate. The first estimate expected 3,5 percent growth. In short, as the American statisticians got their hands on more data, such as the number of new orders as opposed to soft data (for example, confidence indicators), they had to significantly reduce their growth rate.
What mainly drove economic growth in the fourth quarter was domestic consumption by American households. However, as mentioned earlier, their purchasing power has come under pressure due to the sharp rise in inflation. This has to do with the fact that their wages have not risen very quickly in recent months. That puts serious doubts on the expectation that the spending bonanza in the US will continue, as the forecast of low car sales also indicates.
In addition, a day before the interest rate committee was to start its deliberations, the regional central bank in Atlanta reported that growth in the first quarter of this year will be significantly lower than previously predicted. The important indicator, the Atlanta Fed's GDPNow indicator for economic growth, has fallen in a few weeks from 2,5 percent growth to 'only' 0,9 percent growth in the first quarter of this year.
Statements seem strange
With these developments in mind, the comment that the American economy is growing well, as expressed by Fed Chair Janet Yellen, seems somewhat strange. Especially, if we take into account that of the important leading indicators, 12 have performed better than expected in recent weeks. However, there were 14 indicators that caused disappointment. It is also important to mention that the indicators that showed a better picture were mainly soft indicators such as consumer confidence.
Why were interest rates increased in the first place?
For this we must turn to the financial markets in the US. Market interest rates in America have risen significantly because the American economy has done very well in recent months. Inflation had also found its way back up after a long time. The leading ten-year interest rate rose from approximately 1,6 percent in October last year to 2,6 percent at the end of last week. The quarterly U.S. LIBOR rate rose from about 0,8 percent to 1,1 percent over the same period.
If, against this background of a well-functioning economy and rising inflation, the Fed had left the official interest rate unchanged, the bank would risk that investors would take into account a further increase in inflation. As a result, long-term interest rates could quickly rise further and thus frustrate economic growth, the Fed had no choice but to raise interest rates.
This is an important interim conclusion. This means that the Fed no longer directs the markets, but rather follows them. In other words, the central bank has lost control. The Fed is no longer in the driver's seat, but merely pretends that it is.
Fewer interest rate increases not an option
The Fed cannot suddenly have fewer interest rate increases in store for the rest of this year and for 2018. If the bank had done that, investors would immediately have wondered whether the bank was more concerned about the American economy than it indicated.
The bank was also unable to hint at more interest rate increases than previously announced. In that case, long-term interest rates would continue to rise and this would jeopardize the economic recovery. When the US Bureau of Statistics released an excellent jobs report every day before the interest rate meeting, the Fed actually had no choice but to raise interest rates.
The upcoming months
If, partly due to increased and rising inflation, domestic consumption increases less rapidly in the coming months than in recent quarters, and companies receive fewer orders and create fewer jobs, then it would not be surprising if long-term interest rates in the US come under downward pressure . It is logical for the Fed to leave interest rates unchanged after the interest rate meeting.
If, due to political disagreement, the announced tax cuts are delayed and possibly lower than expected, both economic growth and confidence may suffer. Add to that the ever-present chance of protectionist measures by Trump and it is clear that the state of affairs in the American economy does not exactly justify new interest rate increases.
In these scenarios, some upward pressure on the EUR/USD is to be expected. On the one hand because the market would incorporate fewer interest rate increases in America into the price and on the other hand because the election results in the Netherlands. This has given investors more confidence in the elections later this year in Germany and France.