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No More Excuses, Fed

By Jim Pearce on August 26, 2016

At some point not enough bogeymen exist to justify keeping the U.S. economy from operating under normal conditions.

But on the heels of July’s surprisingly strong employment report, Fed chair Janet Yellen may feel compelled to raise interest rates next month if the rest of the economy remains on track. Inflation is also well below the Fed’s threshold, growing by only 0.84% in July on an annualized basis. That’s half of what it was in October of 2014 (1.66%) when the Fed curtailed is Quantitative Easing program, and the fourth straight month it has declined. Although low unemployment usually leads to higher inflation, at the moment there is enough slack in the economy to prevent prices from moving appreciably higher.

Given those factors, it will be interesting to hear what the Fed says as the next meeting of the FOMC approaches, scheduled for Sept. 20 to 21. Already, St. Louis Federal Reserve President James Bullard has waded into the fray, saying in an interview earlier this week that a rate hike in September should be on the table for consideration. And FOMC Vice Chairman Stanley Fischer said much the same thing last weekend, acknowledging “We are close to our targets” for full employment and inflation.

With those statements on the books, Janet Yellen’s comments at Friday’s Jackson Hole conference that she believes “the case for an increase in the federal funds rate has strengthened in recent months” did not come as a big surprise. However, she remained non-committal as to the timing of a possible rate rise, but it’s tough to imagine what excuse she will use not to raise rates if that is the path the Fed chooses next month. The stock market is near record highs, last month’s jobs report was much stronger than expected, and oil prices appear to have stabilized in the $40 to $50 range, which is regarded as sustainable for producers and consumers alike.

But some analysts, including widely-followed financial pundit Jim Cramer, have said that Yellen could trigger a huge stock market decline next week if she’s too hawkish. “If she even mentions putting a rate hike on the table in September, it is entirely possible we will be talking about how ugly next Monday will be, not unlike the down 1,000 point Monday a year ago,” Cramer lamented last Tuesday.

I disagree.

A year ago China had just devalued its currency and surprised the world, triggering a wave of stock market corrections. A second correction followed in January after China did the same thing, but since then the U.S. stock market has fully recovered from those losses and then some. Turns out the single biggest macroeconomic fear most investors had about the U.S. stock market – that its success was largely dependent on China’s continuing “economic miracle” – was unfounded.

Also, oil prices were near a state of free fall at the same time China was devaluing, adding pressure to the concern that deflation might send global stock markets reeling. But oil prices bottomed out in February, and the stock market took off shortly thereafter. Even the “Brexit” vote in late June could only derail the stock market for a few days, refuting one of the last remaining canards of the economic worrywarts.

Now the Fed is left with only rationalizations for keeping interest rates artificially low. Most of these “what if” questions revolve around the upcoming U.S. presidential election, and what the outcome of it may portend for the U.S. economy. What if Donald Trump wins and starts trade wars with some of America’s biggest trading partners, they ask, or what if Hillary Clinton wins and imposes even higher taxes on an already sagging middle class?

These are fair questions to ask, but the Fed should not be in the business of implementing policy based on the unknown. Unless the Fed possesses information the rest of us don’t know, rates should rise. The immediate Wall Street reaction will likely be negative, but in the overall scheme of things a bump in the Fed Funds rate from 0.50% to 0.75% is not going to change the way most investors evaluate their stock and bond portfolios.

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