US Economy

Fed’s slipped up by delaying rate hikes. Here’s why

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The U.S. Federal Reserve has made a "policy mistake" by holding back further rate hikes in 2016 as the U.S. economy is growing strongly and a hawkish monetary policy is therefore needed, according to a report by London-based ETF Securities.

The Fed passed on raising its interest rate target at its March meeting this year citing global economic and financial situation as a risk. Policymakers had previously signaled in December that four rate rises were likely in 2016.

However, the report from ETF securities suggests the lack of hike in March was an error in judgment from the US policymakers. It seems like the Fed's board of governors has become more dovish since the December meeting and the market is now pricing in only one rate hike by the end of the year.

ETF Securities, however, believes the Fed has slipped up.

"Real GDP (gross domestic product) trends indicate that the pace of U.S. economic growth is solid. While the growth path of real GDP is not as strong as pre-crisis levels, there is no evidence of a slowdown. Such a growth path warrants tighter monetary policy," ETF securities said in a statement.

Citi slashes US outlook, risks ‘very evident’

ETF Securities' stance is, however, contrary to what a number of economists believe. Official data shows the U.S. economic growth slowed to 1.4 per cent in the fourth quarter of 2015, down from 2 per cent in the third quarter of 2015. A number of banks have already revised their outlook for the year due to factors such as global economic uncertainties.

Citigroup, for example, recently downgraded its outlook for the U.S. for 2016-2017, saying the risks were very evident. The revised figures show that the GDP will grow by 0.9 percent in the first quarter and 1.7 percent for the year. "Despite such tepid growth prospects, we project a slow decline in the unemployment rate to 4.7 percent by end-2016, and 4.5 percent by end-2017," William Lee, head of North America economics at Citigroup said in his research outlook. He predicted inflation to remain subdued.

However, James Butterfill, head of research and investment strategy at ETF Securities says while the Fed is currently stuck in a liquidity trap, the U.S. economy is strong to sustain another rate hike.

"Looking at the key factors that have historically defined rates hikes, namely the non-accelerating inflation rate of unemployment (NAIRU), wage growth and nonfarm payrolls, all suggest a rate hike should occur. Delaying hikes will likely have a much more negative impact on asset classes and the global economy," Butterfill told CNBC

He further explains that current real GDP has recovered and the quarterly dip in the figures is very common during rate hike periods.

"Investors and industry leaders become very concerned with the impact that the first rate hike will have on the economy – a short term negative fund. This in turn leads to lower corporate confidence and consumer confidence, leading to a temporary dip in GDP growth, this is history repeating itself."

The report also says that currency volatility remains elevated as investors continue to worry over the potential for rate hikes derailing the U.S. economic recovery. However, the ETF Securities report says there is no danger of modest rate hikes impacting economic growth with the threat actually coming from uncertain policy guidance from the Fed.

"Such a situation seems circular, with markets fretting over Fed decisions and the Fed concerning themselves with market volatility – an issue outside the scope of its mandate," the report says, predicting that the U.S. recovery will continue in 2016.

The minutes of the March meeting highlighted the consensus within the Fed around a cautious outlook for the economy.

"If the Fed's global concerns diminish in the near term, their worries about the U.S. economy should also lessen," David Kelly, chief global strategist at JP Morgan Asset Management told CNBC via email. "The U.S. economy, like the global economy, faces challenges ranging from a very volatile and unpredictable race for president to uncertainty about the strength of any potential bounce-back in corporate earnings. Moreover, equity valuations look close to fair value rather than cheap in absolute terms. "

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