Economic Commentaries


With so much attention being directed at this coming week's FOMC policy meeting, we think a few underlying considerations should be kept in mind. These reflect themes we have repeatedly enunciated.

The Federal Reserve has made it very clear that it wants to raise short term interest rates and begin some sort of glide path toward a normalized interest rate environment. Proponents of this desire use two basic arguments. One is that the Fed needs to raise rates so that it would have room to ease in the event of an economic downturn. A second is that with uninterrupted economic growth for the past several years and the jobless rate having declined significantly, there is no longer an economic emergency and thus no need for an emergency interest rate.

A move toward policy would have been facilitated long ago if fiscal and regulatory policies had been growth oriented, but unfortunately this has not been the case. Thus, an emergency rate has been necessary. Nonetheless, raising rates now so they can be cut later if necessary is like banging one's head against a wall to see if it hurts.

Because there is no longer an economic emergency the second justification for a rate increase is more compelling. However, we would argue emergency conditions still exist even though growth has progressed and the domestic economy seems on more solid footing. But the rest of the world is not healthy and as a result the odds of a global recession have actually increased in the past six months rather than having declined. Moreover, global deflation is a greater threat than inflation and inflation in the U.S. is far from the Fed's target and will likely move further from the Fed's target in the near term.

It seems to us that an interest rate hike could aggravate rather than ameliorate these trends. Higher short term rates could potentially invert the interest rate yield curve if long term rates actually fall with falling inflation expectations. A rate increase would further tighten financial conditions which have tightened recent because of international tensions. It could deter mortgage financing activity harming cash flows to households and businesses and weakening demand. A rising rate environment would harm construction in our view and of course it could further strengthen the dollar exchange rate, inflicting more harm on multinational company earnings, revenue, and capital investment. In other words, the cure of normalizing rates could end up being worse than the disease of zero interest rate policy.

These considerations relate directly to business activity prospects. But there is another compelling reason and that is that the Fed has no friends in Washington. Therefore any policy misstep, especially in an election year, could invite retribution and potentially a further loss of independence. And if something untoward to happen to the economy such that a policy reversal would become necessary, the Fed would lose credibility with financial markets and its participants. Is a policy move in the midst of modest growth and no inflation worth the risk? We think not.

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