Vanguard’s economists discuss expectations for U.S. rates

The U.S. economy continues to recover, yet the Fed has repeatedly delayed an increase in short-term interest rates. Vanguard Senior Economist Roger Aliaga-Díaz and Senior Investment Analyst Andrew Patterson discuss the factors behind the Fed’s inaction, what the Fed will be looking for going forward, and the likelihood that they’ll raise rates in 2016.

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Vanguard Perspectives® Noni Robinson: Andrew, the Fed continues to delay additional rate hikes and they recently lowered their longer term expectations. What’s Vanguard’s outlook for the U.S. economy and what do we expect from the Fed in the near term and in the longer term?

Andrew Patterson: So, Noni, despite recent volatility, right, Brexit included in that, our outlook for the economy hasn’t really changed much since the end of last year. We still see growth of around 2%, maybe Brexit drags that down by, let’s call it 10 basis points or so at the high end. But for the most part, it remains very much the same; 2% growth, inflation continuing to trend back toward 2%.

Roger Aliaga-Díaz: I would say in terms of the U.S. economy, clearly, the strength of the labor market—the progress of the labor market—has been significant. For all intents and purposes, we are pretty much at what we could define as full employment including the divisions of unemployment that are broader than just people looking for a job. People that have been on the sidelines of the labor market have been coming back in. So clearly, in terms of Fed policy, the macro fundamentals of the U.S. economy are strong enough to basically keep the Fed moving in terms of rate hikes. But the Fed, even since last year, I think has been considering very strongly also the global developments and with the Brexit shock, as Andrew was pointing out, being one of those significant events that leads the Fed to be very cautious against tail risks even though the domestic economy is strong. So, because of the Brexit shock, because of the Fed approach to ponder global developments like this, we see the Fed pushing out the schedule of rate hikes even beyond what you would tell from looking at just U.S. economy numbers alone, perhaps into December, perhaps into the first quarter of 2017. As we can see also, we have U.S. elections coming up in the third quarter, right? So, those are all the key considerations, in addition to the strength of U.S. economy, that the Fed needs to take into account.

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