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Market Rout Could Throw Fed Off Course

Market Rout Could  Throw Fed Off CourseMarket Rout Could  Throw Fed Off Course

Federal Reserve officials are playing it cool for now, but roughly $2.5 trillion of stock market value wiped out in the past three weeks and a possible consumer pullback could throw the Fed off its course of gradual interest rate hikes.

Policymakers continue to argue that the threat will pass, but the risk that the selloff will hit the main engine of US economic growth–household spending–gets bigger, the longer markets remain depressed Reuters reported.

Fed research and other studies estimate that up to 6% of any drop in household net worth gets passed through and results in less spending. It means that unless the market recovers soon, upwards of $150 billion in consumption will be lost in coming months–a drag of close to 1% of gross domestic product.

Fed policymakers meet on Tuesday and Wednesday for the first time since raising interest rates in December. While no move is expected, investors will parse their statement to see how recent events have influenced the central bank’s outlook.

 Concerns Rise

Since its last meeting, oil prices have plumbed new multi-year lows, worries about China’s growth have roiled stock markets, and Fed officials have voiced concerns that a recent drop in US inflation expectations could mark a dent in household and business confidence.

Central bankers typically discount market swings as largely irrelevant to monetary policy, unless they become big enough to impact business investment, hiring or household spending.

Outside analysis and a Reuters review of data suggest this could be such a case, given how wealth effects of the market slide, if sustained over time, could erode a large chunk of the economic growth now expected by the Fed.

In addition, other indicators of consumer spending habits have begun to flat-line or suggest households may tighten their purse strings.

The personal savings rate ticked higher through late last year to reach 5.6% of disposable income in November, up from the 4.8% average for 2013 and 2014. This could signal a return of consumer caution that characterized the subdued early stages of the recovery from the 2007-2009 recession when US households focused on repairing their finances.

 Gathering Clouds

Owners’ equity in real estate, which surged in recent years as housing prices recovered after the recession, stalled through the first nine months of last year at around 56% of mortgage debt.

Household net worth as a multiple of disposable income, had by last year recovered from the financial crisis thanks to rising home and stock prices, but growth stagnated throughout 2015. Both measures are important proxies for consumption as they improve access to credit, bolster confidence and make households more ready to spend.

“When you put it all together, if equities keep softening and you get rising savings and if consumer confidence starts to decline you have a narrative that points in the same direction of maybe less consumption growth,” said Ben Herzon, senior economist with the Macroeconomic Advisers consulting firm.

The consultancy is forecasting 2.5% US growth for this year, just above the Fed’s base forecast of 2.4%. It plans, however, to update that after weighing the impact of the stock market slide against positives, such as continued employment growth and expected wage increases, and the boost to households provided by cheap energy.

In fact, by the end of last week oil prices had crept back above $30 a barrel and stocks had recouped some of their losses. But if that proves to be a brief and the slump continues, it could do real damage.

Fed policymakers view continued improvements in the US jobs market as such an important driver of economic growth that none of the recent developments on their own are likely to change the Fed’s 2016 outlook, just yet.

The Fed also does not seem ready to scale down its plans to move further away from zero interest rates, with a possible second rate increase in March or April, and as many as three more before the yearend.

 

Financialtribune.com