What 118 Fed Rate Increases Since 1948 Show as Economy Falters

Washington (May 6)  The U.S. economy has again fallen into a first-quarter pothole. News of the biggest trade deficit in more than six years on Monday pushed many economists to revise their estimates to show that the world’s largest economy contracted in the first three months of 2015 for a second straight year.

Don’t panic, goes the cry. Temporary factors such as a harsh winter and labor dispute at West Coast ports help explain the slump as does the suspicion that government spending, trade and inventories now open every year on the soft side. Services are picking up and the dollar’s surge has stabilized.

Indeed, since 2010, economic growth averaged just 0.3 percent in the first quarter, compared with 2.9 percent in the remaining three quarters of the year, according to Jan Hatzius, chief economist at Goldman Sachs Group Inc.

So the forecast of Hatzius and most economists remains for the U.S. to soon accelerate anew and for the Federal Reserve to finally raise its key interest rate in September.

Strategists at Deutsche Bank AG in London are less convinced of a rosy scenario for Fed Chair Janet Yellen and colleagues.

The analysts, Jim Reid and Craig Nicol, are watching the trend in nominal gross domestic product, which is output unadjusted for inflation. That’s because, they say, it provides a handy guide for how healthy the Fed considers the economy as it allows for both growth and prices.

Inappropriate Increase

Since 1948, the Fed has increased its benchmark on 118 occasions against a quarterly backdrop in which the average growth in nominal GDP was an average 8.6 percent, Deutsche Bank’s strategists wrote in a report published Wednesday.

Only in the third quarters of 1958 and 1982 did the Fed shift when nominal growth was undershooting 4.5 percent and the latter action was even reversed a month later.

So for virtually every rate increase since Harry S. Truman was in the White House, nominal GDP was growing 4.5 percent or faster, with 112 occurring when it was above 5.5 percent.

That may give Yellen pause, according to Deutsche Bank. Since the recovery began in the middle of 2010, nominal GDP growth has averaged 3.9 percent in a range between 3.3 percent and 4.7 percent. For the first quarter growth was at 3.9 percent and is now likely lower because of the trade data.

While Reid and Nicol accept it could spike between now and September, it would still require quite a rebound in activity to deliver 4.5 percent.

In their eyes, the risk is that if the Fed still raises rates when nominal GDP is so weak the central bank may come to regret it. Minneapolis Fed President Narayana Kocherlakota is already calling a hike this year “inappropriate.”

“There is no template in history for assessing the likely consequences of raising rates when growth is this low, asset prices are generally this high and with debt still so large,” said Reid and Nicol. “To be safe we’d like to see nominal GDP consistently get to at least a 5-handle before rates rise.”

Source: Bloomberg