The long-awaited Fed decision is finally at hand. It’s a very close call as to whether or not they’ll hike. It appears the “they won’t hike” camp has the slight advantage going into the decision, but it could easily go either way. Here’s the pro and con arguments for a Fed hike, followed by our analysis.
Starting out the arguments in favor of the hike is a simple and true claim. Zero interest rate policies were designed as a reaction to the an economic crisis. While the economy isn’t running on all cylinders now, the US has clearly left the crisis period of the event. As such crisis policies are no longer justified.
Second, the US economy is showing a fair bit of strength. The homebuilding sector is seeing very renewed levels of optimism as people are finally buying houses again. And autos are on fire, US car sales are hitting all-time high record levels.
Third, it’s not the Fed’s job to keep the stock market elevated. Their dual mandate is to keep inflation at a moderate level and provide for employment growth to the extent that they have the ability to influence it. The Fed does not have a mandate to keep stock prices high and diminish market volatility.
Fourth, though this argument rings less true, the Fed needs to hike so that it will have ammo for the next downturn. When things get bad again, if the Fed is off zero, it can cut back to zero to create new stimulus. Though if raising now causes a contraction which causes you to cut again in the near future, what has been accomplished?
Finally, hike proponents argue, and with seeming merit, that one rate hike will have but a small effect on the economy. And since people have been planning for a hike for literally years now, it should not cause a great market disturbance.
On the against the rate hike side, the argument starts first and foremost with the US dollar. The 20% surge higher in the US dollar over the last year has been primarily caused by the Fed tightening interest rate policy while the rest of the world eases. Interest rate hikes will cause the dollar to go further up, placing more strain on struggling economies with dollar debts.
Which brings up point number two, emerging markets have taken a bath. China, Russia, Brazil; all the biggies except India have suffered drastic sell-offs in their equity markets, and now investors are pulling money out of those country’s bond markets. With these global growth drivers now seemingly in reverse, the rest of the world will also face contraction. The US may be growing now, but will it still be as China grinds to a halt and Brazil and Russia further contract?
On a related note, point number three is that weak commodity prices make a hike unnecessary and counterproductive. With demand for a wide variety of commodities, including oil, copper, steel and food products all at low levels and prices for them in the dumps, it seems evident that the world faces no incoming inflation or overexpansionary threat.
And that brings us to point four, which is that inflation is nowhere near the Fed’s target level, let alone high enough to cause concern. Sure, employment is strong and some sectors such as homes and autos show promising signs of revitalization. But is that reason alone to douse the recovery in cold water?
From this observer’s viewpoint, the balance of the evidence clearly weighs toward a no-hike decision. The US economy is showing some strength, but the world economy certainly isn’t.
Particularly since the US dollar is the world’s reserve currency and many foreign countries are heavily indebted in US-dollar denominated obligations, it would be simply cruel to drive up their borrowing costs further in this dark time.
The US is doing alright for itself, but any further moves that weaken the likes of Brazil, Russia, and China during this already dark period for them will end up causing economic contraction and job losses in the US sooner or later. In a globalized economy, no economy is immune to the struggles of the rest.
The US is the strongest boat in a globally stormy sea. That doesn’t give the US the mandate to put the brakes on its own economy though. Once Europe and the emerging economies see growth start to kick in, then it will be a better time to consider a real rate-hiking policy.