It may be impossible for the Federal Reserve to raise interest rates until the rest of the world economy improves, Fed board member Lael Brainard said on Tuesday, in the most direct acknowledgement yet of how weak global markets could handcuff the U.S. central bank.
Brainard, who is hyper-attentive to the impacts of globalization given her prior role as head of international affairs at the U.S. Treasury, sketched out a world in which a strong dollar, weak overseas demand, and even Chinese wage rates were holding back the U.S. recovery and potentially slowing the Fed's progress towards more normal monetary policy.
Absent convincing evidence otherwise, Brainard said the dismal performance of first-quarter U.S. gross domestic product may signal a more permanent slowdown, and that the Fed needed to enter a phase of "watchful waiting" before raising rates. Her remarks further weighed against the already slim chance of a rate hike at the June policy-setting meeting, and could mark an even more indefinite hold on a decision that had seemed locked in for this fall.
"The underlying momentum of the recovery has proven relatively susceptible to successive headwinds," Brainard said. The risks associated with a Greek default, a slowdown in China, and continued problems in Europe "may persist for some time," she said. "There is value to watchful waiting while additional data help to clarify the economy's underlying momentum."
Brainard has been on the Fed board for a year now, and has kept a relatively low public profile. But she used a speech at the Center for Strategic and International Studies on Tuesday to give her most extensive policy remarks yet, sounding a bearish note based on the issues she knows best.
Brainard indicated that given the strong dollar, the impact low oil prices are having on U.S. energy investment, and other factors, the time for a rate hike may still be far off.
"We do experience cross currents from abroad and they do affect our recovery and they affect the policy response," Brainard said. "Net exports have been a big drag. That means manufacturing is weaker than it would otherwise be and that does transmit into the labor market."
Her comments set her apart from a sizeable group of Fed officials who have maintained that the international effects on the U.S. will prove "transitory," and in particular that low oil prices will encourage consumer spending. Several months into oil's swoon, that isn't happening.
Brainard did not explicitly rule out a rate increase this year, conforming to the Fed's current policy that as of the June session it will conduct a "data dependent," meeting-by-meeting discussion of whether it is time to hike rates after six years at the near-zero level.
But she also made a forceful case for why dismal first-quarter growth may be more than an aberration, and why it is proving more difficult than expected for the Fed to "diverge" and begin raising rates when the rest of the world economy isn't performing well.
The situation has become frustratingly circular. Bad data at home postpones a rate hike. But because the global economy is so spotty, good U.S. data draws in foreign capital, pushes up the value of the dollar, and weighs on the recovery, making it more difficult for the Fed to raise rates.
The U.S. economy contracted 0.7 percent in the first quarter, according to revised data issued last week, and was seen growing just 0.8 percent in the second quarter, according to an influential Atlanta Fed survey.
"The limited data in hand pertaining to the second quarter do not suggest a significant bounceback in aggregate spending," Brainard said. "It would be difficult ... to dismiss the possibility of a more significant drag on the economy."
The Fed's policy setting committee meets in June and for the first time since the crisis will have the door open to a rate increase. Fed officials have signaled a June hike is unlikely, while investors have eyed December as the likely date of liftoff.
Along with the difficulty overseas, Brainard said there was still "some distance to go" before U.S. job markets are fully healed from the 2007 to 2009 financial crisis and recession, given the still-high levels of part-time unemployment and low labor force participation.
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