Fed Will Fight Even a Slow Economy -- Heard on the Street

By Justin Lahart Features Dow Jones Newswires

Nothing can stop the Fed.

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So far this year the economy hasn't lived up to investors' hopes and dreams, with the Commerce Department announcing last week that gross domestic product grew at just a 0.7% annual rate in the first quarter. Economists' expect things to pick up, but the second quarter is off to an inauspicious start. The Institute for Supply Management's manufacturing report on Monday indicated factory activity slowed in April, and car companies' April sales reports Tuesday fell short of forecasts.

Federal Reserve policy makers don't seem worried and view slower first-quarter growth as "transitory."

At the least, it seems policy makers are sticking by the projection they made when they tightened in March that they would be raising rates two additional times this year. Yet investors seem doubtful -- futures have one rate increase priced in this year, but put the odds of a second one at only about 50%.

The skepticism may be misplaced. True, the Fed has over the past several years shown a tendency toward skittishness, dialing back its plans on rate increases whenever markets looked shaky. But with global economic growth improving, markets around the world have been tranquil lately, and the threat of financial crises spinning out of Europe or emerging markets seems diminished. Nor would a drop in a pricey-looking U.S. stock market likely phase the Fed.

The current situation is a test for the Fed's view that what would have been considered slow growth in the past could still boost inflation to levels that call for higher rates.

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Policy makers' projections for long-term GDP growth -- the economy's just-right speed for employment and inflation -- are now centered on just 1.9% versus 2.65% six years ago. Many economists put the pace even lower. Morgan Stanley, for example, has it at 1.5%.

Crucial to the Fed's view is the economy's strong record of adding jobs even though economic growth has been tepid. What matters now is that unemployment has fallen to the point where there appears to be little slack left in the labor market, and employers have to pay up for the workers they need. The Labor Department reported last week that its employment cost index -- a broad range of wages and benefits -- rose 0.8% in the first quarter, marking its biggest gain in nearly a decade.

For investors, this has the makings of an unfamiliar world where even an uninspiring economy inspires the Fed to raise rates.

Write to Justin Lahart at justin.lahart@wsj.com

(END) Dow Jones Newswires

May 03, 2017 15:55 ET (19:55 GMT)