As Federal Reserve chairman in 1998, Alan Greenspan said the U.S. could not remain an oasis of prosperity in a world beset by financial turbulence. Now Janet Yellen must decide whether that counsel still holds true.
The turbulence in the stock market, triggered by economic uncertainty in China, has investors questioning whether the U.S. can withstand weakness abroad and wondering what that means for the timing of the Fed’s interest rate liftoff.
“If market turmoil continues, the Fed will hold off hiking at the next meeting,” said Jonathan Wright, a professor at Johns Hopkins University in Baltimore and a former economist at the central bank’s Division of Monetary Affairs. “These market movements are getting sizable and raise … risks to growth and inflation.”
Investors have sharply marked down the probability of a September rate increase by the Fed. They now see only a 22 percent chance that the Fed will raise its targeted interest rates at the central bank’s gathering Sept. 16-17, down from 48 percent at the start of last week.
“We move our call for the first rate hike from September 2015 to March 2016,” Michael Gapen, chief U.S. economist at Barclays Capital in New York, and his colleague Rob Martin wrote in a note to clients.
Atlanta Fed president Dennis Lockhart, who spoke Monday in Berkeley, Calif., said he still expects the first rate increase later this year, though a stronger dollar, weaker yuan and falling oil prices complicate the U.S. outlook. He declined to spell out whether he favored moving in September or delaying. On Aug. 10, Lockhart said he viewed liftoff in September as a “live possibility.”
Yellen, who has led the Fed almost five years now, told Congress on July 15 that the Fed was likely to raise rates later this year, assuming its forecasts for stronger growth and lower unemployment were realized.
Former Treasury secretary Lawrence Summers evoked the memory of the 1997-98 Asian financial crisis in a Twitter message Monday. Summers, a professor at Harvard University, said the world “could be in the early stage of a very serious situation” as he made the argument against a Fed move. As a deputy Treasury secretary in 1997-98, Summers dealt with fallout from the turmoil in Asian markets.
“The balance of risks is towards more financial instability, slower growth, disinflation and deflation,” Summers said in an interview. “That’s not a time to be raising rates.”
Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York, said, “There are some definite parallels to 1998 when you had the Asian financial crisis raging.”
Just as in 1997-98, emerging markets are becoming unmoored, fanning fears about global growth and financial market stability. The crisis back then eventually triggered the near bankruptcy of U.S. hedge fund Long-Term Capital Management and ended only when the Greenspan Fed cut rates.
So far, at least, the current turmoil has not gotten that bad. There’s been little or no talk in the markets of financial stresses in the U.S. Big U.S. banks, in particular, are supposed to be well fortified against market turmoil, having passed Fed stress tests earlier this year that posed a scenario of equity prices falling about 60 percent over the space of a little more than a year.
Although emerging markets are suffering, they’re still in better shape than then were in 1997-98, when several of them had to turn to the International Monetary Fund for assistance, said Paul Ashworth, chief U.S. economist at Capital Economics in Toronto.