News analysis

For the Fed's next move, watch US elections

It is just a matter of time before United States interest rate jitters again consume the attention of the world's financial markets.

At last week's rate-setting meeting, the US central bank unleashed a global stock market rally after halving the number of rate increases it expects for this year to just two quarter-point moves.

As its chair, Dr Janet Yellen, observed after the meeting, proceeding cautiously to remove the ultra-loose monetary policy in place since the global financial crisis eight years ago would allow the Fed to "verify that the labour market is continuing to strengthen, despite the risks from abroad".

The move caught many US analysts wrong-footed. Some of them had believed that the Fed would stay its course to take pre-emptive action to choke off any nascent inflation pressure, given that the US economy is on track to achieve 2 per cent growth this year and that unemployment looks headed further south below the 5 per cent level.

But even the Fed's relatively dovish views at its latest rate-setting meeting may still prove too hawkish for the financial market.


Traders at the New York Stock Exchange earlier this month. So far, the Fed has avoided being accused of taking sides in this US presidential election campaign, but after successfully guiding market expectations lower on further rates hikes this year, the Fed may now stand pat and do nothing altogether until after the election. PHOTO: BLOOMBERG

According to Bloomberg, traders see only a 22 per cent chance of the Fed raising rates twice this year. Fed funds futures suggest that the Fed may even hold fire for the entire year, rather than lift interest rates by the planned two times.

The Fed has managed to avoid the heat of the US election campaign so far, but if history is any guide it may be only a matter of time before it becomes ensnared, even though its monetary policy is ostensibly all about economic performance.

Why is this so? The problem the Fed appears to be facing is that while its mandate is to worry about the US alone, one lesson from the violent market movements after its first rate hike in almost a decade in December is that any tightening may provoke an international backlash that may reverberate and hit the American economy.

This is given the fact that the Fed is planning to tighten at a time when other major central banks such as the European Central Bank and the Bank of Japan have taken steps to push their interest rates deeper into negative territory to try to stir their own economies back to life.

A rate hike next month looks unlikely and even June seems too soon in the light of the uncertainties generated by Britain's referendum on its European Union membership.

That suggests that July might be the earliest time for the Fed to tighten. However, there will still be a big question mark as to whether it can do so - as the US presidential election will be only five months away by then.

The Fed has managed to avoid the heat of the US election campaign so far, but if history is any guide it may be only a matter of time before it becomes ensnared, even though its monetary policy is ostensibly all about economic performance.

This is in view of the fact that the election campaign has become heated over economic issues, with voters concerned about job security and stagnating income flocking to candidates such as Republican front runner Donald Trump and Senator Bernie Sanders as he challenges Mrs Hillary Clinton for the Democratic party nomination.

Historically, there is more pressure for the Fed to act if the incumbent in the White House is seeking re-election.

Going back 50 years, then Fed chairman Arthur Burns was blamed for unleashing runaway inflation with his economic prime-pumping efforts to help Mr Richard Nixon to get re-elected in 1972. His successor once removed, Mr Paul Volcker, was accused of torpedoing Mr Jimmy Carter's chance for a second term in 1980 with his tight monetary measures to tame inflation.

Mr Volcker's successor, Mr Alan Greenspan, got a shelling from Mr George H.W. Bush, who accused him of losing him his second term in office in 1992 by cutting interest rates too slowly.

And 1½ months before Mr Barack Obama's re-election four years ago, the reticent Mr Ben Bernanke, Dr Yellen's predecessor, relaxed US monetary policy in a big way by launching another round of quantitative easing - printing US$40 billion (S$54.3 billion) a month - to jump-start the US economy.

At that time, Mr Obama's challenger, Mr Mitt Romney, had criticised Mr Bernanke's previous quantitative easing efforts as not helping Americans to get back to work and that he would not reappoint Mr Bernanke to a third term if he were to be elected as president.

So far, the Fed has avoided being accused of taking sides in this election campaign, but after successfully guiding market expectations lower on further rates hikes this year, the Fed may now stand pat and do nothing altogether until after the election. That may mean the next rate hike may come only in December at the earliest.

In a world where much of the trades and borrowings are still priced in US dollars, this will give global financial markets a much-needed reprieve if it materialises.

At least, it may stabilise stock prices around current levels, barring a financial earthquake from another huge economy such as China.

On the local front, any further delay in hiking US interest rates will lessen the pressure on local interest rates to move up as well - giving hard-pressed businesses a much-needed boost in a year of slowing economic growth - since the Singapore dollar is tied to a basket of currencies, including the greenback.

So it may be worthwhile to track the US election campaign for other than the entertainment value that candidates like Mr Trump are providing. It may well influence the direction of US interest rates - and ours.

A version of this article appeared in the print edition of The Straits Times on March 22, 2016, with the headline 'For the Fed's next move, watch US elections '. Print Edition | Subscribe