Fed may delay rate increases

WASHINGTON – Just as the U.S. job market finally has strengthened, the Federal Reserve now confronts a new worry: a sputtering global economy that’s spooked investors across the world.

The economic slump could spill into the United States, potentially weakening job growth and keeping inflation well below the Fed’s target rate. Such fear has led some analysts to suggest that the Fed might wait until deep into next year to start raising interest rates – and then raise them more gradually than expected.

“I’m beginning to think that the Fed might delay (a rate increase),” said Bob Baur, chief economist at Principal Global Advisors, an asset management firm. “If we don’t see a better situation in Europe and better things out of Japan and stability in China, they might hang on just a little bit longer.”

Yet so far, the prospect of continued lower rates – which make loans cheaper and can fuel stock gains – is being outweighed by investors’ mounting fears of weakness from Asia to Europe to Latin America. After shedding 223 points Monday, the Dow Jones industrial average is now more than 5 percent below its September peak. Americans with stocks in their retirement accounts have taken a beating – at least for now.

On Tuesday, solid earnings from several large U.S. banks gave stocks an initial boost before share prices faded by the close. The Dow lost about 6 points.

Since the recession ended five years ago, Fed officials often have stressed that their policies were devised to nurture the U.S. economy and job market alone. But Fed officials are now assuring international financial leaders they will closely monitor the effects of the Fed’s policies on overseas economies.

And the Fed’s vice chair has publicly acknowledged that the turmoil abroad could lead the Fed to act more cautiously.

“If foreign growth is weaker than anticipated, the consequences for the U.S. economy could lead the Fed to (raise rates) more slowly than otherwise,” Vice Chair Stanley Fischer said in a speech last weekend.

Fischer’s remarks followed a rash of data last week that pointed to slower growth worldwide. Germany reported sharp declines in factory output and exports, which raised fears that Europe’s biggest and strongest economic power could fall into recession. China’s efforts to rein in government and private debt have slowed its expansion. And consumers in Japan still are spending listlessly after a big sales tax increase took effect in April.

“The world economy’s engines have been sputtering,” said Douglas Porter, chief economist at BMO Financial Group.

Against the backdrop of a limping global economy, the United States looks like a comparative standout, even though the U.S. economy hasn’t yet regained full health. That widening gap has boosted the value of the dollar. Compared with a basket of other currencies, the dollar has risen 7.5 percent in the past three months, TD Economics estimates.

A stronger dollar makes American goods more expensive in foreign markets and can reduce U.S. exports. It also makes imports cheaper for Americans and puts downward pressure on U.S. inflation.

Michael Hanson, an economist at Bank of America Merrill Lynch, estimates that a 10 percent increase in the dollar’s value over a year would reduce the U.S. inflation rate by a quarter of a percentage point. The Fed’s preferred inflation gauge is already a half-point below its 2 percent target, and an additional drop could give the Fed another reason to delay a rate increase.

A further decline in inflation “would likely stop Fed discussion of a mid-2015 liftoff (in interest rates) in its tracks,” Hanson said in a note to clients.

Hanson and some economists still predict that the Fed will start raising its benchmark short-term rate in mid-2015 as the U.S. economy picks up. But most say the Fed seems more likely to push its timetable further into the future than to move it forward.