US Economic Outlook after the Fed’s Rate Hike

Analysis by Lorenz UNGER

Janet_Yellen_official_Federal_Reserve_portrait
Janet Yellen is the current Federal Reserve Chairman – Public domain

Notwithstanding international setbacks, such as the prolonged Euro crisis, plunging oil prices and sagging economic growth in China, the US economy in 2015 fared in line with expectations, with its annual Gross Domestic Product (GDP) growth falling 0.5 % short of its 2.5% target. Irrespective of this flat growth rate, the Federal Reserve (FED) decided to raise its interest rates on December 17th for the first time since the outbreak of the global financial crisis. Undoubtedly, this shift in monetary policy will have a decisive impact on the US Economy in 2016. Whether or not this policy change will contribute to strengthening or weakening GDP growth will be discussed subsequently.

In theory, an increase of the federal funds rate should lead to an appreciation of the US Dollar (USD). Although the FED only raised its interest rates by 25 basis points, whilst further increases are imminent, another factor puts additional weight on the USD – divergent monetary policy of other Central Banks. The European Central Bank (ECB) is committed to maintaining quantitative easing, and China, given its most recent stock trading suspension, will keep interest rates low to crank up its economy. This currency depreciation of the USA’s largest trading partners, against an already strong USD, will have a significant effect on the USA’s Balance of Trade. An extension of its trade deficit could put a strain on GDP growth; the question is whether consumption can shoulder this burden.

In consideration of domestic circumstances it seems that the odds are in favour of the economy absorbing the deficit. A decisive factor is the continuous fall in unemployment in 2015, which currently ranks at 5%. If employment keeps rising, general purchasing power and consumption will increase and thus bolster the economy. Given the fact that two-thirds of the Unites States GDP is derived from consumption, prospects for economic growth remain feasible.   

Conclusively, the faith of the US economy in 2016 crucially depends on how much drag an appreciated dollar puts on the rest of the economy. At present, the economy is in decent shape to handle the trade-downswing. However, no GDP growth miracle should be expected and therefore level in slightly above the 2% margin.

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