Economic update: The Fed keeps the taps on for a little longer
Figure 2On the back of good economic news, long-term market rates were on the rise….
In September, the Federal Reserve announced it will wait for more evidence on the progress of the recovery before adjusting the pace of its asset purchases.
Inflation aside, here are a few issues that help explain the Fed’s decision:
- Market interest rates: Positive economic news from the major economies in the world have pushed up market interest rates, counteracting the effects of monetary easing (see Figure 2). For business, this has translated into higher funding costs and lower margins, which at worst could choke off the recovery.
- Unemployment rate: The US economy continues to have an unemployment rate above the 6.5% target set by the Fed, indicating that spare capacity exists. As our analysis on the next page shows, most advanced economies’ labour markets still bear the scars from the crisis and have not yet recovered.
- Fiscal squeeze: In October, US lawmakers will need to approve an extension of the debt ceiling and the US budget. The impact of past inaction has meant that sequestration — automatic cuts to the Federal Budget — have reduced one percentage point off US growth this year.
Throughout October, we will also be monitoring how emerging market policymakers react to the Fed decision.
We expect the currencies of the vulnerable emerging economies to come under less pressure in the coming weeks. This however will be short-lived, as good economic news in the US will increase the likelihood of a gradual monetary tightening.