It was exactly what Federal Reserve chair Janet Yellen didn't want.

Suddenly, Yellen and her advisers were in the position where a tiny and essentially insignificant increase in interest rates was in danger of setting a cat among the pigeons, and contributing to the global instability that in the end discouraged her from raising rates.

In the event, Yellen decided this was not the time for change, citing lower inflation and global turmoil. Because of that decision, Canadian borrowers get a reprieve — but it may be only a short one.

As recently as this summer, the people who watch such things were almost unanimous in thinking today would be the U.S. central bank's first rate increase in more than nine years.

Momentous change

In historical terms, it would certainly signal a momentous change in strategy. Since long before the financial meltdown of 2007 and 2008, the Fed had been using rate cuts as the solution to every problem. In fact there are many analysts who blame those low, low rates for the U.S. housing bubble that led to the financial crisis, something former central banker Alan Greenspan has conceded may be true.  

And while there was some trepidation about how a September rate hike would affect emerging markets and U.S. trade, wide acceptance of an inevitable rate rise was based on optimism. 

At June's meeting of the group that advises Yellen, the Federal Open Market Committee was not unanimous, but a majority agreed that the U.S. economy had kicked from contraction into recovery and that an increase in rates would be needed soon. 

As I pointed out at the time, U.S. interest rate increases are not good for everyone, and one group likely to suffer would be Canadian mortgage holders as long-term rates rise.

But from a wider perspective, the fact that some of America's best-informed bankers and economists thought the U.S. was heading for a sustained recovery that would soon lead to inflation was actually pretty good news. Because one main reason for raising rates is to block the inflation that can creep in and weaken an economy.

Devastating effect

By last week that optimism, and the consensus that the Fed would hike rates, had slipped considerably. Some of the big guns who opposed a U.S. rise in rates started to make a lot of noise.

Worries about the Chinese economy and wild swings in global stocks had weakened the consensus that the U.S. needs a rate rise.

Vancouver Daily Life 20150914

A Fed rate hike would have made mortgages on homes like these Vancouver condos more expensive. But Yellen says rates could still rise this year. (Darryl Dyck/Canadian Press)

The harshest opponents claimed to speak for the emerging markets, those developing economies hit hard by a rising U.S. dollar. People like former U.S. treasury secretary Larry Summers and representatives of the IMF and World Bank warned rising U.S. rates could have a devastating effect on the global economy.

In its simplest form, the argument is that rising rates and a rising U.S. dollar will suck money out of the developing world, making a grave situation dire.

Other opponents said a rate rise would hurt the U.S. stock market, and ultimately U.S. exports.

Despite the dire warnings, by Monday, economist opinions on whether the Fed would raise rates or not were split evenly. 

Falling odds

"Of the 75 who submit their forecasts to Bloomberg," wrote James Mackintosh in Tuesday's Financial Times, "37 expect rates to stay flat on Thursday. Thirty-seven expect rates to rise. The remaining one splits the difference by predicting the Fed will raise rates by only half as much as usual."

By yesterday it had changed again. A new reading of the Bloomberg consensus of economists showed only a 30 per cent chance of a rate rise.

One reason for the change of view was that U.S. inflation numbers that came in below expectations and showed that overall, U.S. prices were falling. That made a rate rise to fight inflation seem hardly worth causing a ruckus.

In fact lower inflation, and lower expectations of future inflation, were two of the main reasons Yellen and her committee decided not to hike rates. Yellen said the falling price of imports plus a continued decline in energy costs is holding consumer prices down. 

Turmoil in the global economy had also contributed to the decision to stay the course.

But she and her committee participants believe those effects are temporary. A rate rise has been postponed she said, not cancelled.

"Most participants continue to think that economic conditions will call for or make appropriate an increase in the federal funds rate by the end of this year," Yellen said in response to a question. She specifically did not rule out a rate rise in October.

That said, the committee has scaled back its optimism, meaning it remains possible that Canadian borrowers worried about a rise in long-term rates will have even longer to adjust. Certainly an increase in rates always seems to be over the next hill, but never here. 

Yellen insisted today that falling U.S. unemployment — which recently hit a seven-year low of just over five per cent — will have an impact and eventually prices will begin to rise. She said holding off too long created the danger that the central bank would have to raise rates suddenly and sharply once inflation started to soar.

"I don't think it's good policy to then slam on the brakes," she said.


Follow Don on Twitter @don_pittis

​More analysis by Don Pittis