Take Five With Bruce Bittles: Why is the Fed hesitant to raise interest rates?
During their late-October visit to Madison, we asked Bruce Bittles, chief investment strategist for Robert W. Baird & Co. and the author of Baird Market Notes, and Craig Elder, senior fixed income research analyst for Baird, why the Fed has been so slow to raise interest rates during the current economic recovery. From their perspective, the key metric to watch is wage growth, as they explain in this two-part interview. In part 1, Bittles weighs in on the Fed’s likely response to key economic indicators and a host of other issues. Part 2, featuring Elder’s critique, can be found here.
IB: From what you understand about recent Fed guidance on this topic (interest rates), when do you expect to see the Fed begin to raise interest rates? Do they first want to see the economy stack success on metrics?
Bittles: I think the Fed is watching the employment numbers. Now, the unemployment numbers are skewed because so many folks have left the labor force, so it gives the false impression that labor markets are really sound. Now, there are a lot of jobs coming on-stream, but the problem is that there has been no wage growth. [Editor’s note: After we interviewed Bittles, the Bureau of Labor Statistics reported a surprising jump in wages for November (up .4%).] So middle-income households and low-income households are still suffering. Inflation, typically, is a function of income, so if wages aren’t going up, it’s pretty difficult to generate any sustained inflation. So I think that’s the first thing the Fed is going to watch — wages.
I also think they will keep their eye on the inflation rate. We could have pockets of inflation. We do already have some. Health care and education are certainly two areas that are running high in terms of pricing and inflation, but broadly speaking, inflation is pretty well under control. The Consumer Price Index over the past 12 months is up 1.7%, and the Fed’s target is 2%, so we haven’t even been able to get to that 2%. What is so disconcerting about that is that this is after five years of 0% interest rates and four years of money printing, and yet the inflation rate remains problematic.
So as a result, I think it’s going to be quite a while before the Fed is forced to raise rates. They are trying to get inflation up, so they would like to see wages go up, which would certainly help the middle class. The middle class has been hurt through all of this. The Fed’s money printing has helped a few people who own stocks and bonds, but unless you own a large portfolio of stocks and bonds, you really haven’t participated in this recovery, and this recovery has been one of the weakest on record. So they would like to see wages go up and they would like to see some inflation return, and that would mean the economy is probably healing.
Right now, with slow growth and low inflation, the risk is that an outside event could really cause the economy a lot of trouble. So unless you’re in a strong, vibrant economy, an outside influence could really disrupt your economy.
IB: So that one key metric is wage growth, which would help the Fed hit its inflation target. What about labor force participation, which is at a 35-year low?
Bittles: I don’t think the Fed is looking at labor force participation. Some of that is skewed because of the aging of the population. I think they are going to watch wages, and wages last month [September] were down two-tenths of a percent. They need to grow about 3.5% to 4%, and they are not doing that. They haven’t done that in quite a while. They have been growing at about 2%, which is about the inflation rate. Real wages have not grown at all.
IB: If improvement on the U-3 unemployment rate isn’t improving wages, what will?
Bittles: I think what has to happen is business has to finally begin to spend some money on capital equipment. We haven’t seen any growth there. The consumer is not going to drag this economy any higher. They are not in great shape. Their wages haven’t grown. The savings rate is low, so you can’t count on the consumer. I think you have to count on business, and what that requires is strong fiscal policy out of Washington. Without that, all the Fed’s work is for naught. The current situation can really only be improved with strong fiscal policy [and] a strong and favorable business climate, which we don’t have.
IB: So is this more of a Washington problem than a Fed policy issue?
Bittles: Absolutely. What the Fed is doing with 0% rates and money printing is just trying to cover the misbehavior of the federal government.
IB: Would you have a recommendation at this point for the policymakers?
Bittles: Free markets are what works. You have to reduce the amount of regulation in the economy. Lowering taxes would be a big help, and …
IB: Lowering tax rates?
Bittles: Tax rates, particularly for corporations. They are way too high, the highest in the world. So why wouldn’t we try to help our corporations? That’s where job creation is going to come from. We need less regulation and a friendly business climate out of Washington, which we have not had. We need a full-blown attempt to produce as much energy as we can in this country. We’re now the largest oil producer in the world, and areas that are producing oil, like Texas and the Dakotas, are doing well. And if you look at what’s happening in the states that are experiencing great growth, like Texas and Tennessee and Florida, it’s because they don’t have state income taxes. So lower taxes work. All the problems with employment are in areas with heavy taxes, such as California, Illinois, and New York. So businesses and individuals are leaving those states and going back to where they can find good jobs and lower taxes, and that’s going to have to be adopted by the entire country eventually, or else we’re going to continue with the slow-growth environment, and who does that hurt? It hurts the middle class.
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