Too Soon

The U.S. economy was, and still is, widely seen as the world’s bright spot. But at the time, bond traders signaled the Fed was being too upbeat and overlooking the risks of falling energy prices on growth, as well as its ability to boost rates.

In January, when Treasury yields indicated the likelihood the U.S. would face a bout of deflation within a year, Fed officials lifted their assessment of the economy, played down low inflation and said cheaper energy would help boost consumer buying power in its policy statement.

A shift in the Fed’s stance occurred in March, when policy makers cut their forecast for how much they expected the key rate would rise this year. Fed Chair Janet Yellen also made the case for a cautious approach to rates in a March 27 speech.

By that time, U.S. consumer prices were in the midst of falling for a third month as a raft of disappointing reports on economic growth and consumer spending showed that lower gasoline prices did little to boost demand.

Investors such as DoubleLine Capital’s Jeffrey Gundlach warned the Fed against raising rates too soon as a slump in spending and hiring in the energy industry may cause a “ripple effect” in the broader economy.

‘Quite Cavalier’

“The market had been worried that the Fed was quite cavalier,” said Wan-Chong Kung, a Minneapolis-based money manager at Nuveen Asset Management, which oversees more than $100 billion. “That tone seems to have shifted.”

Based on Morgan Stanley’s analysis of futures trading, the Fed will start raising its benchmark rate in December. A month ago, the market was anticipating a September rate rise.

Holding borrowing costs low for longer doesn’t mean higher inflation is a sure thing. After all, inflation has fallen short of the Fed’s 2 percent goal for 34 straight months.

One reason is the dollar, which has appreciated 18 percent against 10 global currencies since the end of June as central banks outside the U.S., particularly the European Central Bank, stepped up stimulus measures. A stronger greenback helps keep inflation in check by holding down import prices and curbing demand for U.S. exports.

Enough Time

“Where we see some headwinds in overall inflation is still the strong dollar,” said Doug Trevallion, a fund manager at Babson Capital Management, which oversees $217 billion. That means “some more price weakness to come through.”

Giving the economy enough time to regain its footing may prevent the nightmare scenario Gundlach laid out, where higher rates derail the expansion and force the Fed to backtrack.