With markets in turmoil, Fed could demur on interest rate hike this year

Economic analysts have for months predicted that 2015 will be the year that the U.S. Federal Reserve finally raises unprecedented near-zero interest rates, held low to stabilize the economy during the Great Recession. However, recent global market turmoil, spurred in part by a nosedive of the Chinese benchmark stock market, has led many to believe that the rate hike could be delayed — possibly until next year.

The Federal Open Market Committee (FMOC), the central bank’s body responsible for rate change decisions, is scheduled to meet in September, October and December. It could approve a rate hike during any of these three meetings.

"If the economy evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the federal funds target,” Federal Reserve Chair Janet Yellen said last month. But she stressed the ultimate decision rests on "how much progress the economy has made in healing from the trauma of the financial crisis."

In response to the crisis, the Federal Reserve implemented a loose monetary policy in which it lowered interest rates, expanded the supply of money and made it more accessible to the public. This helped stave off economic collapse during the Great Recession and has been seen by many to be central in growing the economy during the subsequent recovery period.

While the Federal Reserve last year ended its large-scale bond-purchasing scheme known as quantitative easing, which saw it pump more than $3 trillion dollars into the stagnant economy, it has kept the near-zero benchmark interest rate over concerns that growth, wages and labor market conditions have not been sufficient on their own.

“Much of the growth that you observed [since the Great Recession] has been propped up by monetary stimulus,” said David Blanchflower, a professor at Dartmouth and former member of the Bank of England’s Monetary Policy Committee. As a result, the central bank is “going to be incredibly cautious in removing it.”

While the U.S. unemployment rate has ticked down to prerecession levels, wage growth has remained stagnant and economic inequality in the country has increased.

The mixed economic picture in the U.S. has been accompanied this year by an even worse economic picture in Europe and, most recently, China’s stock market tumble, which culminated in record losses on Monday and a subsequent shock to the global financial system which saw the Dow Jones industrial average fall close to 1,000 points at one point on Monday, before a mini-recovery on Tuesday that fell way to another dive as the closing bell approached.

Despite Monday’s global market shakeup, the president and CEO of the Federal Reserve Bank of Atlanta, Dennis Lockhart, suggested that day that the FMOC would still likely change course in the months to come. “I expect the normalization of monetary policy — that is, interest rates — to begin sometime this year,” he said.

But a number of prominent economic voices this week came out against a rate hike, partly because of global market instability.

In an op-ed for The Financial Times on Monday, former U.S. Treasury Secretary Lawrence Summers said a rate hike risked plunging the country back into financial crisis. “At this moment of fragility, raising rates risks tipping some part of the financial system into crisis, with unpredictable and dangerous results,” he wrote.

Meanwhile, other analysts predisposed to a rate hike have delayed their predictions for when it might occur.

"Although we continue to see economic activity in the U.S. as solid and justifying modest rate hikes, we believe the Federal Reserve is unlikely to begin a hiking cycle in this environment for fear that such a move may further destabilize markets," Barclays economists Michael Gapen and Rob Martin said in a research note on Monday. The economists, who previously predicted that the Federal Reserve would raise the interest rate at its next meeting in September, say it now won’t likely happen until March 2016.

In fact, according to a survey of leading business economists released on Monday, only 37 percent of those polled said the Federal Reserve would hike the main interest rate in September, though the majority said it would probably still come this year.

In August, a separate poll by The Wall Street Journal found that more than four-fifths of the economists it surveyed said a hike was coming in September.

The change in predictions demonstrates just how fickle the business of forecasting federal interest rates can be.

“The 80 percent of economists that have said rate raises were coming are looking like idiots,” said Blanchflower. “Yellen is going to be cautious.”

“Basically central bankers will always be mindful of making an error, and it’s clear that the worst error is to raise rates to soon,” he said.