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Raising the Stakes

Now that the full extent of China’s economic weakness is being flushed out into the open, all eyes are focused on the Fed to see if it will begin raising interest rates later this month. On this point the Fed governors seem genuinely split, engaging in a rare public debate over what in the past has been a discussion held solely behind the closed doors of their boardroom.

Conventional wisdom is that this week’s August jobs report is the decisive data point that swings the vote one way or the other. If jobs growth was too high – generally regarded as an increase of more than 275,000 to the national payroll – that suggests our economy is beginning to heat up in which case a preemptive interest rate hike now will help stave off inflation later.

Continuing with that logic, it won’t be long before all of those gainfully employed American workers begin bidding up the prices of just about everything they like to buy unless higher savings rates and costlier loans induce them to put more cash into money market funds and less into spending.

But a weak employment report – fewer than 225,000 new jobs added – would mean that the threat of inflation is muted and the Fed will not feel compelled to proactively address it just yet. A tightening labor market is usually a precursor to rising wages, which thus far in 2015 have risen at roughly 2%, or about the same as the Consumer Price Index.

In short, there has been nothing in the employment data this year to suggest that most people have a whole lot more money to spend – in absolute or relative terms – than they did a year ago.

My concern is that an interest rate hike now – regardless of the employment situation – could cripple an economy just learning to walk under its own power after being weaned off years of central bank intervention. To paraphrase Winston Churchill, never before has so much been so dependent on so little information. I say that because I believe the moment the Fed formally announces it is raising rates the bond market will go through a major sell off, which in turn may trigger a similar sized liquidation in the stock market.

So to pin a decision of that magnitude on one report strikes me as a bit reckless. The monthly jobs reports are notoriously inaccurate; almost always revised in later months, and sometimes by a significant amount. And even after making seasonal adjustments, the employment figures are often skewed by one-time events that are just as quickly reversed.

For example, everyone knows the energy sector has lost tens of thousands of jobs this year due to plunging oil prices, but does anyone really know the full extent to which that has indirectly affected the jobs count in other industries, both positive and negative?

Regardless, the employment report was released Friday morning and revealed that only 173,000 new non-farm jobs were added in August, with the manufacturing sector losing the most jobs since July of 2013. However, the unemployment rate fell to 5.1%, its lowest level in over seven years.

The stock market reacted negatively to that mixed news, as the S&P 500 Index fell by more than 1% in the first hour of trading on U.S. exchanges.

So here we are, only a few weeks removed from the stock market’s dizzying plunge in August and a similarly short time span away from the Fed’s next major decision point.

It’s worth noting that in the meantime the European Central Bank announced it has reduced its inflation forecast and will keep interest rates at record low levels for the foreseeable future. Combined with increasingly weak economic news out of China, one wonders precisely where the impetus for a surge in inflation will be coming from in the near term.

Perhaps the least convincing rationalization for raising rates I’ve heard is that the act itself will serve as proof that the American economy has, in fact, made it all the way back from its post-2009 lows. In a certain sense it can be argued it has since stock market had, until recently, been trading at record highs.

However, the value of a stock market index never tells the whole story, and in this case it ignores trillions of dollars of quantitative easing that pushed it to those record highs but is no longer present.

In my opinion the Fed would be wise to wait it out, and leave rates unchanged until there is definitive proof of a real threat of inflation. The American dollar has become so strong that many U.S. companies rely on domestic consumption to remain profitable, so to discourage spending by raising rates on the only people for whom a strong dollar makes no difference doesn’t make much sense.

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