The US: Fed Up, Fed Down

Federal Reserve bank of Cleveland. Image courtesy of skeeze,

​The US Federal Reserve is seen by many in America as the first - or last – line of defense for the economy. 

Its chairman, 6 governors, and 12 regional presidents are supposed to sound the alarm, and act upon threats. They man the battlements at times of trouble and open the gates when peace is upon the land. And – here comes the crucial part – it can still be said that as the US goes, so goes the global economy.

So when the Fed hints at raising interest rates it may send emerging markets reeling. And when its leaders push toward cutting rates, liquidity becomes more abundant.

But when the fed communicates it might do one, and then tells the world it could opt for the other, things become interesting. 

And tricky, too.


Over the last few months tepid consumption, inflation and profits in the US plus Brexit uncertainty push the Fed back again toward a “no hike” stance.

Real personal consumption expenditures (PCE), for example, rose +0.3% in May even as the y/y rate crept down from +3.0% to +2.7%. Over the past three months, however, PCE has gained +3.0% annualized, boding reasonably well for Q2. 

Real disposable income gained only +0.1% to a +3.2% y/y rate. No inflation was visible in the report as the Fed’s favorite measure, the PCE core rate remained at +1.6% y/y. It has ranged from +1.6% to +1.7% for five straight months.

Consumer confidence rose a sharp 5.6 points in June from 92.4 to 98.0. While evaluations of both the present and future rose, the divergence between the two remains very wide, near levels last seen in the recession, suggesting possible concern over the presidential election.

Corporate profits gained +1.8% in Q1, but it was only the first gain in three quarters and only the second gain in the last six quarters. On a real basis, profits are still shrinking -5.4% y/y. At the same time, real investment is growing only +0.4%.  Negative growth in profits and investment at the same time are an ominous sign for an economy, and although that is not the case currently, it is very close.

The Brexit vote shocked global financial markets, and in the US the S&P 500 lost 5.3% in two days. However the rapid sell-off appears to be a knee-jerk reaction, and the market has now recovered 90% of those losses. 

Yet the bond market is still showing caution. The day before the Brexit vote the yield on the 10 year US Treasury was 1.74%, but fell as low as 1.46% over the following two days, and has only crept back up a few basis points since then. As a result, over the same period, the yield spread between the 10 year and the 3 month Treasury securities also shrank from 1.43% to 1.19% and has only recovered a few basis points since then.

As far as the real US economy goes, Brexit is likely to have almost no effect.  We estimate that over the period 2017-2019, cumulatively, US GDP would at most lose -0.2% from what it would be otherwise - a virtual rounding error.

The turmoil, lack of inflation, and still tepid consumption, mean the Fed is surely on hold for July, and is quite likely on hold for September.  Financial markets see only a 13% chance of a hike in 2016 at all, and they even project an 8% chance of a rate cut by September. But these projections are probably still over-reacting to the Brexit vote and we think they will moderate soon.  

We do not expect to see a rate cut in the near future.

Ludovic Subran 

Chief Economist 

Euler Hermes 

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