To Hike or Not To Hike – That Is the Question Facing the Fed

jenet

I can’t remember a time when there was such serious disagreement over what the Federal Reserve should do regarding a rate hike. I have been reading several articles written by analysts and economists in the past few months and I must confess to being confused by the divided opinions.

Part of my confusion is caused by the fact that the Fed keeps reiterating that they are “data-dependent” therefore the focus on every little bit of data, no matter how trivial is being dissected. For example: The August’s employment report was viewed by some Wall Street analysts as lackluster.

The U.S. government’s August employment report, showed non-farm job growth of 173,000, a number lower than expectations of 200,000. The jobless rate was rosier than forecast, however, falling to 5.1 percent—the lowest since April 2008. Average hourly wages rose a greater than expected 0.3 percent. The July payrolls were revised higher to 245,000.

Now employment numbers are often revised, especially July & August because close to 30% of survey participants are often on holidays. On average, August employment numbers have been revised up 66,000 each year! I expect the actual employment numbers will be in the range of 235,000 new jobs being created which is much better than expected. July saw another 30,000 jobs added and June saw another 14,000!

There are those who argue that while unemployment did drop to 5.1%, that is a “soft” unemployment figure. The participation rate is down. The number of part-time workers wanting full-time jobs is still high and the new employment trend is not that encouraging. Plus the Fed has a dual mandate to promote full employment and stable prices. They have a 2% inflation target which is not even close to being achieved for a while because of low oil prices and a strong U.S. dollar.

Why raise rates when the economy is barely getting back to a stable 3% growth rate compared to the old 4% to 5% range. Raising interest rates could further strengthen the U.S. dollar putting downward pressure on the export market and hurt the recovery in the housing market.

Those who think we should raise rates likewise have an array of data to support their case. GDP grew 3.7% in the second quarter. If you take out the weather-related first-quarter 2015 GDP figure, GDP growth is running well over 3%. Given the global headwinds currently buffeting economies, that’s about as good as it’s going to get. This economy has weathered tax increases and the abrupt changes of Obamacare, as well as a significant drop in capital spending related to oil production and has “kept on ticking.”

“If there is a recession in our near future, as David Rosenberg points out, it would be the first recession ever that did not see consumer spending or employment go down for the count.”

Keep in mind, in the history of the United States, they have never had a period longer than nine years without a recession. This relatively weak recovery is getting long in the tooth. Do you want the Fed to confront the next recession with another round of massive quantitative easing as the only policy tool left in their tool box? When their own research shows that Q.E. wasn’t very useful! We can clearly see the distortions caused by Q.E. in both the stock & bond markets around the world.

What do you need in order to begin to increase interest rates? Inflation is under control and according to most Fed economists seems to be ticking higher. Unemployment is moving lower. The economy is doing quite well. If not now, when? How much better do you want things to get before rates are taken back to something close to normal?

I would not argue for a rapid rate hike. In fact, I would prefer 1/8 of a point at every other meeting, rather than the typical quarter point. A gradual tightening cycle, perhaps getting to 1% by the end of 2016 and 2% by 2017, makes a lot of sense to me.

rock

However, the U.S. financial markets are exhibiting the classic behavior patterns of an addict.  Just a hint that the Fed may start slowing raising rates has already caused the financial markets to throw an epic temper tantrum! The same thing happened under the leadership of Ben Bernanke when he announced the ending of the Quantitative Easing program!

What do you think the Federal Reserve should do? Postpone or raise interest rates?

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One thought on “To Hike or Not To Hike – That Is the Question Facing the Fed

  1. You are quite correct, another round of massive quantitative easing is all that is left for the Fed to counter another Recession. Though I did read somewhere about negative rates, but I don’t think that person was being serious.

    Added to the economic conditions and facts, as you mentioned, is the public and political perception of the Fed. Would continued dovish non-committal policy start making them look bad? I think they are backing themselves into a bit of a corner now because enough data seems to be present to meet their previously dovish, non-committal policy remarks regarding increasing rates.

    I agree with you about the 1/8 of a point increase and at least the ground work of a plan or schedule going forward. The free money addicted market would probably react badly, but at least with a multi-step plan in place there would be the needed certainty to provide stability and direction going forward.

    But that would make too much sense.

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