U.S. Fed chair Janet Yellen gives Canadian borrowers a brief reprieve: Don Pittis

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

Suddenly, Yellen and her advisers werein the position where a tiny and essentially insignificant increase in interest rates wasin danger of setting a cat among the pigeons, andcontributing 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.

• Federal reserve hold U.S. rates steady
• Fed chair Yellenwarns Canadian homeowners

As recently as this summer, the peoplewho watch such things were almost unanimous in thinking today would be the U.S. central bank'sfirstrate increase in more than nineyears.

Momentous change

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

And while there was some trepidation abouthow a September rate hikewould 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 MarketCommitteewasnot unanimous,but a majority agreed that the U.S. economy had kicked from contraction into recovery and that an increase in rates would beneeded soon.

As I pointed out at the time, U.S. interest rateincreases are not good for everyone, and one group likely to suffer would beCanadian mortgage holdersas long-term rates rise.

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

Devastating effect

By last weekthat 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 stockshad weakened the consensus that the U.S. needs arate rise.

The harshest opponents claimed to speak for the emerging markets, thosedeveloping economieshit hard by a rising U.S. dollar. People like former U.S. treasury secretary Larry Summersand representatives of the IMF and World Bank warned rising U.S. ratescould havea devastating effecton the global economy.

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

Other opponents saida rate risewouldhurt the U.S. stock market, and ultimatelyU.S. exports.

Despite the dire warnings, by Monday, economist opinionson whether the Fed would raise rates ornot 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-sevenexpect 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. Anew reading of the Bloomberg consensus of economistsshowed 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 madea rate rise to fight inflation seem hardlyworth 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," Yellensaid 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 Canadianborrowers worried about a rise in long-term rates will have even longer to adjust. Certainly an increase inrates always seems to be over the next hill, but never here.

• House prices may stay high in Canada: Here's why

Yelleninsisted today that falling U.S. unemployment which recently hit a seven-year low of just over fiveper 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 onceinflation started to soar.

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

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