Hurricanes’ Impact Could Make US Fed More Hawkish

September 20, 2017 Updated: September 23, 2017

The devastation caused by hurricanes Harvey and Irma and now Maria will make the U.S. Federal Reserve‘s job of conducting monetary policy trickier, but it is unlikely to change the Fed’s plans of raising rates. It is conceivable, however, that in the near future, the Fed could be forced to cram more rate hikes in a shorter time frame—something it wants to avoid.

“On the surface, the hurricanes could make it [the Fed] a little more hawkish … over the next year, but in the near term, because the economic data are quite muddled by the storms, … it probably warrants more dovishness, meaning the Fed delays the next rate increase,” said Sal Guatieri, a senior economist with BMO, in a phone interview.

He says the rebuilding efforts will add to GDP growth over the next year on net, and thus it’s possible the hurricanes would make the Fed more likely to raise rates.

Torsten Slok, chief international economist at Deutsche Bank in New York, agrees that the next rate hike could be delayed a quarter or two due to the hurricanes, but the economic effect is temporary.

“The hurricanes will have a significant impact on the data, but not on Fed policy,” Slok said via email. The reason for this, Slok explains, is that any economic slowdown due to the hurricanes will be made up in future quarters and the Fed aims to look through the temporary volatility.

The problem for the Fed is that economic data such as GDP, inflation, and labor market indicators get distorted due to the hurricanes’ effect. This muddying of the data can last for several quarters, says Guatieri.

The “data distortion” has already begun, as inflation got a boost from a surge in gasoline prices and August’s consumer price index (CPI) rose the most since January.

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“Storm-related disruptions and rebuilding will affect economic activity in the near term, but past experience suggests that the storms are unlikely to materially alter the course of the national economy over the medium term,” according to the Federal Open Market Committee (FOMC) statement on Sept. 20.

In September 2005, the Fed under Alan Greenspan raised its key rate to 3.75 percent in its first policy meeting after Hurricane Katrina. It said then that higher energy and other costs have the potential to move inflation higher.

The Janet Yellen-led Fed acknowledged that the hurricanes’ effect will provide a temporary boost to inflation, but that it will still remain below the desired 2 percent in the near term.

In her press conference, Yellen said third-quarter economic growth would be held down and September’s jobs report may be affected, but that those impacts will be reversed. Thus, a few disappointing bits of economic data should not be expected to divert the Fed from its rate hike plans.

As it did in June, the Fed continues to lean toward one more rate hike in 2017 and three more in 2018; however, the average year-end targets for the fed funds rate are slightly lower. The long-run fed funds rate is now expected to be 2.75 percent instead of 3.00 percent.

The impact of the hurricanes was not expected to affect the Fed’s projections for growth, inflation, and unemployment. Compared to June’s projections, the Fed now expects marginally stronger growth with slightly lower unemployment and inflation through 2019.

Aside from the hurricanes, the U.S. economic momentum has been picking up. Second-quarter GDP was revised up to 3.0 percent.

Canadian Experience

BMO revised third-quarter growth for the United States down to 2.0 percent from 2.4 percent, but raised fourth-quarter growth to 2.9 percent from 2.5 percent. Macroeconomic Advisers/IHS Markit estimates the hit to GDP at just below one percentage point due to the hurricanes.

That impact is roughly what the Canadian economy suffered during the spring of 2016 from the Alberta wildfires. But it has roared back to lead the G7.

The Bank of Canada expected 2016 second-quarter GDP to fall by 1 percent, but that there would be an outsized increase in the third quarter as rebuilding began. Governor Stephen Poloz said then that the Alberta wildfires would be a “sharp, but temporary hit to the economy.”

Back in mid-2016, a rate cut was still on the table and many investors and economists couldn’t see the Bank of Canada raising rates until 2018. Instead, after a year of above-potential growth, the Canadian central bank has raised rates in two straight meetings—the second hike came without publishing updated economic projections and holding a press conference with its governor.

Financial markets interpreted the Fed statement as more hawkish than expected. U.S. Treasury bond yields and the dollar index jumped higher upon digesting the Fed’s news release.

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Follow Rahul on Twitter: @RV_ETBiz