The payroll data for February showed that the US economy added 295,000 jobs, bringing the unemployment rate down to 5.5 per cent. This is close to the non-accelerating inflation rate of unemployment (or NAIRU) for the US, the point at which the economy begins to overheat and the rate of inflation accelerates. Yet, there is no sign of that happening. Personal consumption expenditure inflation remains tame at just 0.2 per cent, while the Consumer Price Index printed negative in January. The fall in the unemployment rate was accompanied by disappointing wage growth and an increase in the number of people dropping out of the labour force, raising questions about the strength of the recovery.
At the same time, US retail sales fell in February, making it the third consecutive month of decline. While this is being attributed to bad weather, softness in retail sales indicates that Americans have been conservative in their spending habits even though their disposable incomes have been enhanced by the drop in fuel prices. Defying the stereotype, Americans have decided to use their extra income to save for a rainy day or reduce their debt level. US stock markets recovered only after the release of this data point led to a rethink on the timing of the rate hike.
The key question is whether the American economy can accommodate any more strength in the dollar before starting to hurt. The dollar has been rallying against the euro for eight straight months, touching a 12-year high as the European Central Bank begins its quantitative easing programme. The stronger dollar is not only a headwind for the US economy but it is also putting a lid on inflation by lowering the price of imports. In other words, it is doing the work that higher interest rates are supposed to do, that is, tightening financial conditions. Raising interest rates too soon may be an over-reaction to a single data point on jobs.
Yet, contrary opinions continue to be heard, making it necessary for the Fed to state its position on how it sees the currency impacting its rate decision. Retaliating against a slew of complaints from CEOs of large companies with international operations who have been suffering on account of the rising dollar, the President of the Federal Reserve Bank of Dallas, Richard Fisher commented: "It's not the end of the world". He went on to make the rather puzzling claim that sharp gains in the US dollar are good for the US labour market.
After the US Fed releases its post-meeting statement later this week, there will be much quibbling over the language used by it. The key to look out for is whether or not it continues to use the word "patient", when it talks about normalising monetary policy. Fed Chairperson Janet Yellen had earlier indicated that the Federal Open Market Committee (FOMC) uses this word to mean that it does not expect to raise rates "in the next couple of meetings". So, if indeed, a June rate hike is to be factored in, this word must go from the statement. However, its removal would still not mean that a rate hike is imminent. The statement will also be examined for clues on the rate at which the Fed continues to raise rates after the initial hike.
Tailpiece: The Reserve Bank of India justified its out-of-meeting rate cut earlier this month by referring to the global trend towards easing. As currency markets are factoring in an impending rate hike by the US Fed, the rupee has started sliding.
Abheek Barua is chief economist, HDFC Bank. Bidisha Ganguly is principal economist, CII