The final countdown?

Based on the statement issued after this week's FOMC meeting, it looks as if the Fed might just possibly maybe see its way to raising interest rates some time soon.  The weather-related slowdown in the US economy in the first quarter of this year has given way to growth that the Fed portrays as "moderate", which has helped to tighten the labour market slightly -- or, in Fedspeak "underutilization of labor resources diminished somewhat".

Taking no lessons from Mark Carney's ill-fated attempt at providing "forward guidance" at the Bank of England, the FOMC has explicitly tied the timing of its possible tightening to two specific factors: further improvements in the employment market, and signs that inflation is moving back towards the 2 percent goal that the Fed aims for in the medium term.  The most recent employment report, for the month of May, was very strong, and there's no reason to think that the positive trend in job growth is about to reverse itself. As for inflation, the monthly data released today show a jump in the headline rate as a result of a rebound in gasoline prices, but the "core" rate, which excludes gas and other volatile (sorry!) items, remains stable below the 2 percent target.

A survey by Bloomberg suggests that almost every Wall Street analyst now expects rates to start rising later this year; that seems about right. Even when rates do start to rise, however, the Fed believes that economic conditions may warrant keeping the Fed funds target below "normal" levels for some time. Equity markets have been reassured by this, but it's hardly a surprising statement: even if the Fed were to raise rates by 25 basis points per quarter, it would still take the better part of half a decade to get back to what we used to regard as normal levels.

What does all this mean for Canada? The Bank of Canada's Financial Stability Report last week showed that the Bank sees excessive household indebtedness, much of it related to home purchases and most of it induced by record-low borrowing rates, as a key risk to the economy. A couple of surveys over the past week have delivered conflicting data on whether households are reining in their appetite for debt, but there can be little doubt that even a fairly small rise in rates would quickly push a lot of households over the edge. Financial sections of the press are starting to fill up with advice to cut borrowing, shift to a fixed rate mortgage, and so on.

Despite its concerns over debt levels, the Bank of Canada will hold off on following the Fed for as long as it can. No matter how long it delays, however, it seems inevitable that the Canadian economy will be less able to cope with higher rates than its neighbour to the south.