SPECIAL REPORT

ECONOMIC RESEARCH
2nd February 2015 - No.8
Author: Thomas Julien

United States: The Fed leaves the door open

US growth was once again sustained in Q4-14 and is likely to remain solid at the beginning of 2015, driven by
the positive effects of the fall in the oil price and the upswing in the job market. In parallel, even though
inflation can be expected to remain under the 2% target for a while, the Fed does not appear to be unduly
concerned about this and the door still seems to be open for a first rate hike in the middle of 2015, with a risk
that it may be postponed in September (if wage growth remains sluggish). In any case, the rate tightening
cycle will be very gradual.
Following the annual rotation of the FOMC members, we also update our "hawk-o-meter" scale, which
suggests that regional members are less likely to dissent this year.
The Feds first meeting n 2015
Unsurprisingly, and as there was no press conference, the
FOMC meeting on 27 and 28 January provided little
information about the Feds future intentions. The description
of the growth environment proved to be largely positive, with
the growth rate qualified as "solid" (versus "moderate"
previously), purchasing power driven by energy prices and
once again "strong" job creations.
The comments on inflation were changed slightly, but the
message remains roughly similar: the impact of the fall in
energy prices will be temporary and inflation is still expected
to converge towards the 2% target in the medium term.
In parallel, the reference to "considerable time" has been
permanently removed from the press release. It is now only
stated that the Fed will remain patient before raising rates.
Yet, one novelty should be noted : the Fed added
international developments to the list of factors that it takes
into account in its monetary policy assessment. While this
addition may suggest that some members could be growingly
concerned by the strengthening of the dollar, we will have to
wait for the minutes of this meeting to obtain further details on
this matter.

Chart 1
US: Contributions to GDP growth (%)

T3-14
Q4-14 (advanced)

2014
S

3
2
1
0
-1

Sources :

Given the further fall in oil prices in Q1 2015 (Chart 2),

household purchasing power will continue to be boosted at
the beginning of the year while the significant labour market
gains also can be expected to support consumer spending.
Against this backdrop, US activity will be solid at the
beginning of the year and the growth rate will remain higher
than its potential, despite a slight slowdown compared with
the trend registered in the middle of 2014. Business capex
spending could nevertheless decelerates with lower
investment expected from the energy sector.

A positive growth environment in the short term

Though lower than expectations, GDP growth remained
strong in Q4 2014 at 2.6% Q/Q ar (after 5.0% in Q3 chart 1),
bringing the growth rate of 2014 to 2.4%. Q4 growth was
mainly driven by a broad-based acceleration of household
consumption (with sharp increases in durable goods,
nondurable and services). Residential investment grew at a
slightly faster pace while investment in structures and
intellectual property remained strong. Only equipment
investment contracted after a strong growth in Q3. In the
meantime, the contribution of foreign trade was highly
negative (-1.0 pt) and was not been fully offset by the positive
trend of the change in inventories. Not surprisingly,
government spending contracted amid the reduction in
defense sector spending.

Chart 2
Oil prices (USD/BBL)
Brent
WTI

130

130

120

120

110

110

100

100

90

90

80

80

70

70
Sources : Datastream

60

60
12

13

14

15

SP EC IA L R EP OR T

The exchange-rate appreciation will have limited effect in

the short term
It is also important to understand the speed of diffusion of the
various shocks the US economy is facing. While the impact of
a fall in oil prices is virtually instantaneous, that of an
appreciation of the exchange rate is slower: the Feds
FRB/US model indicates that the impact of a change in oil
prices peaks three quarters after the shock, versus ten
quarters (two and a half years) for a change in the exchange
rate. The expected appreciation of the dollar (Chart 3) is
therefore unlikely to have a very restrictive impact on US
growth in the short term.
Chart 3
United State: nominal and real effective exhange
rate (1/1/2005=100)

110

Chart 4
US: Total and Core Inflation (%)
Total inflation

Inflation less food and energy

Forecasts
4

0
Sources : BLS, Natixis

110

-2

-2
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Nominal

105

105

Real

100

100

95

95

Table 1
Month-on-month change in the consumer price index
CPI MoM in %

All items
Food

90

90

85

85
Sources : Datastream

80

80
05

06

07

08

09

10

11

12

13

14

15

16

Moreover, while the introduction of a large-scale QE in

Europe has surely underpinned the appreciation of the dollar
recently, expectations that a monetary tightening cycle will
start this year in the United States are also contributing to the
appreciation of the USD. So it is a classic monetary policy
transmission channel that is activated. Yet, Feds
communication on this front must be watched closely.
Inflation will remain lower than the Feds target for some
time
Nevertheless, the appreciation of the exchange rate will
probably have a negative impact on core inflation. In addition
to the direct impact of the fall in energy prices, it should put
additional downward pressures on inflation in the short term
(Chart 4). The reason is that the appreciation of the
exchange rate will reinforce the downward pressures on
imported goods prices (excluding energy, see Table 1),
which are already under pressure from the weak global
growth environment and the deflation in the price of
technological goods. We are actually seeing a dichotomy
between prices of non-energy goods (subject to external
pressures on prices) and prices of services (subject to
domestic pressures (Table 1).

Weight
100

Sep.
0.1

Oct.
0.0

Nov.
-0.3

Dec.
-0.4

14.1

0.3

0.1

0.2

0.3

8.9
5.1
3.8

-0.7
-1.1
-0.2

-1.9
-3
-0.2

-3.8
-6.4
-0.3

-4.7
-9.1
1.0

All items less food and energy

Goods less food and energy
Household furnishings and supplies
Apparel
Transportation less motor fuel
Medical care commodities
Recreation commodities
Education and comm.
Alcoholic beverages
Other goods (inc. tobbaco)

77.1
19.5
3.3
3.5
5.7
1.7
2.0
0.6
1.0
1.6

0.1
0
-0.1
0
0
0.5
0.2
-0.7
0.1
0.1

0.2
0
0.4
-0.2
-0.1
0
0
-0.1
0.1
0.2

0.1
-0.4
-0.5
-1.1
-0.4
0.6
-0.6
-0.9
0.8
-0.6

0.0
-0.3
-0.4
-1.2
-0.4
1.0
-0.3
-0.8
-0.3
0.3

Services less energy services

Shelter
Rent of shelter
Water and sewer and trash collection
Medical care services
Transportation services
Recreation services
Education and com. services
Other personal services

57.5
32.3
31.9
1.2
5.8
5.6
3.7
6.4
1.7

0.2
0.3
0.3
0.4
0.1
0.1
0
0
0

0.3
0.2
0.3
0.6
0.2
0.8
0.4
-0.2
0.3

0.2
0.3
0.2
0.7
0.4
0.3
0
0
0.1

0.1
0.2
0.2
0.6
0.3
-0.5
0.2
0
0.2

Energy
Energy commodities (gasoline)
Energy services (electricity, piped gas)

Sources: BLS

but inflation expectations are relatively well anchored

Although breakeven inflation rates have tended to decline in
the recent period, part of this move could be explained by the
contraction in the risk premium (probability of having high
inflation) and in the liquidity premium, which means they are
to a lesser extent attributable to a fall in the markets inflation
expectations. Moreover, household surveys have stabilised at
reassuring levels. As regards the Michigan survey, the shortterm component has been fluctuating in more or less the
same way it did in 2008 while 5- to 10-year expectations have
remained anchored at 2.8% (Chart 5).

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SP EC IA L R EP OR T

Chart 5
US : inflation expectations (University of Michigan
consumer sentiment)
6

1-year ahead inflation

5-year ahead inflation

1
Sources : Michigan University

0
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

Against this backdrop of stable inflation expectations, and as

Janet Yellen suggested during her latest press conference,
the currently expected inflation dynamics might not be a
major obstacle to an incipient monetary tightening.
No upswing in wages for the time being
Despite economic growth have exceeded its potential while
the labour market posted strong gains, the Fed is faced with
major uncertainty concerning the trend in wages. They have
not shown any sign of a prolonged upturn so far and average
hourly wage figures weakened in December. For the time
being, only the employment cost index shows a slight
acceleration (Chart 6), but it is struggling to break through
the 2% mark in year-on-year terms.
Chart 6
United State: average hourly earnings and
employment cost index (YoY, %)
6

Average hourly earning

Employment cost index (excluding benefits)

2
Sources : DS

1
83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

It is this point in particular that is likely to make the Fed

cautious. It could actually mean that significant slack remains
in the labour market, at least more than what is suggested by
the level of the unemployment rate (currently at 5.6%). Even
though this rate is currently close to its so-called full
employment level (i.e. the level below which wages can be
expected to gather speed), which the Fed has estimated at
between 5.0% and 5.8%, it possibly does not take into
account many discouraged workers that are not included in
labour force statistics or involuntary part-time workers. A
premature monetary policy tightening would therefore run the
risk of deteriorating the economic conditions that are needed
for these workers to come back on the labour market.

Nonetheless, a high level of uncertainty about wage growth

will persist in the medium term. The reasons why wages have
not responded to the labour market normalisation until now
could also be that the conventional determinants of wages
have become less effective (disappearance of the Phillips
1
curve ). On the other hand, as suggested by the San
Francisco research, the sluggishness of wages could be the
result of a wait-and-see stance among companies to make up
for the impossibility of lowering nominal wages during the
2
crisis .
A hike in June is still conceivable
The US economy is not showing any signs of overheating for
the time being: the household debt-to-income ratio has not
yet rebounded, that of companies remains moderate at less
than 45% of GDP and asset prices (mainly equities and real
estate prices) do not seem unduly overvalued. At the same
time, there is a risk that the excess capacity in the labour
market may be under-estimated. In this context, and in the
absence of upward pressures on prices, the Fed can afford to
wait a little before changing direction.
Nevertheless, healthy economic activity and ongoing labour
market normalisation over the next few months, with a slight
acceleration in wages expected in the medium term, should
clearly enable the Fed to tighten monetary conditions during
2015. Given the gradual disappearance of downward
pressures on prices in the middle of the year, Junes
meeting could still be a good opportunity to launch a
tightening cycle, but with a risk that the initial rate hike may
be postponed until September if wages do not accelerate. In
any case, the rate tightening cycle will be extremely gradual.
Hawk-o-meter: more
Even though Yellen was not affected by the historically high
number of votes (three) against the committees decision in
December, the annual rotation of the members is likely to
provide more consensual statements this year with less
regional members dissenting (Table 2).
Annual rotation: As for the hawks, Fisher (Dallas) and
Plosser (Philadelphia) will leave the committee and be
replaced by Lacker (Richmond), who voted against all the
committees decisions in 2012. As for the doves,
Kocherlakota (Minneapolis) will be replaced by Evans
(Chicago), who is also concerned about the low level of
inflation but is open for a rate hike this year. Williams (San
Francisco) will also join the committee. He made relatively
optimistic comments about US economic prospects recently,
but can be considered a centrist.
Meanwhile, a new member could potentially join the Board,
where two seats are still unfilled. The candidate that has
been mentioned, Allan Landon, will first have to be appointed
by President Obama and then confirmed by the Senate. This
potential member is a community banker that is likely to focus
on issues relating to banking regulation. All in all, only Lacker
could be a potential opponent to the Feds decisions this year
(although he voted in favour of the decision at Januarys
meeting), resulting in a broader consensus around Yellen.

See Flash No. 43, Patrick Artus, "United States: How long ago did
the Phillips curve disappear?"
2
http://www.frbsf.org/economic-research/publications/economicletter/2015/january/unemployment-wages-labor-market-recession/
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Table 2
Hawk-o-Meter

Doves

Centrists

Hawks

2014

2015

Fisher
Plosser

Dallas
Philadelphie

Lacker

Richmond

Mester

Cleveland

Lockhart

Atlanta

Powell

BoG

Williams
Dudley

San Francisco
New York

Fischer

Vice chair

Fischer

Vice chair

Dudley

NY

Tarullo

BoG

Tarullo

BoG

Powell

BoG

Brainard

BoG

Brainard

BoG

Yellen

Chairwoman

Yellen

Chair

Kocherlakota

Minneapolis

Evans

Chicago

Vacancies

Vacancies

Potential new member: Allan Landon, Community Banker, center

Source: Fed, Reuters, Natixis

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SP EC IA L R EP OR T

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