Two years ago, a prominent central banker suggested interest rates could rise “sooner than you think” after an unprecedented five-year stretch of easy money. Earlier this week New York Federal Reserve President William Dudley issued a similar warning to financial markets.
Bank of England Governor Mark Carney never acted on his warning in 2014. The U.K.’s key lending rate remained at 0.5% — where it had been since 2009 — and the bank actually cut it to 0.25% earlier this month.
Will history repeat itself in the U.S.? Probably not. The U.S. central bank is more likely than not to raise interest rates before the end of 2016, but the timing is still an open question.
Dudley strongly implied a rate hike could come as soon as September. “We are edging closer to that point in time when it will be appropriate, I think, to raise rates further,” he said. The Fed’s benchmark short-term rate now stands at 0.25% to 0.50%.
Yet the Fed has been on the cusp of rate hikes several times since 2013 — recall the famous taper tantrum — and it seemed on the verge of acting just last spring before backing off.
Even if the Fed holds still after its next big meeting in September, Dudley’s words may have jolted traders. U.S. bond prices fell and yields rose after his comments. The same thing happened in the U.K. in 2014 even though Carney’s warning proved wrong.
“Guidance need not be right if offered by an important central banker,” noted chief economist Carl Weinberg at High Frequency Economics.
Fed officials have been unsettled by a big move into U.S. Treasurys that has pushed yields down even further from already record lows. Lower rates add more stimulus to a U.S. economy that Fed officials worry could lead to higher inflation. Worker pay is on the rise and many industries report a shortage of skill labor that could further push up wage inflation.
A problem for the Fed, though, is that raising rates could strengthen the dollar at a time when most central banks are doing like the Bank of England and cutting them.
A stronger dollar has depressed earnings of U.S.-based multinational companies and hurt export-heavy manufacturers. What’s more, a strong dollar attracts cash badly needed by the economies in Europe and elsewhere.
“The Fed certainly will be hiking interest rates before any other major central bank in the world,” Weinberg wrote in a report. “We are not convinced that world GDP will grow faster if the dollar appreciates.”