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The Fed Plays Politics

By Nick Lanyi on August 31, 2016

Will the Fed raise interest rates in September?

Don’t bet on it.

Fed leaders are supposed to focus on only two goals: maximizing employment and minimizing inflation. That’s it. That’s their job.

But Fed leaders always – always – have an eye on their reputation, and the Fed’s isn’t so hot right now. Fed Chair Janet Yellen is highly respected in policy and economic circles, and the U.S. economy is doing better than most. But let’s face it: no one’s satisfied with the pace of U.S. economic growth, and a growing percentage of Americans have no faith in the PhDs running the show.

The last thing the Fed needs is an accusation of messing with the presidential election. And you better believe that will happen if they hike rates in September.

If the Fed raises Fed Funds by a quarter percentage point, stocks will sell off. Lending rates for mortgage and small business loans will go up.  Bonds would take a beating. The last economic reports before Election Day might well show a slowdown as a result. Most likely, an economic downturn will hurt Hillary Clinton and incumbents of both parties while helping Donald Trump and challengers with a “throw the bums out” message. But regardless of the actual impact, you better believe the pundits will have a field day spouting off about the monkey wrench the Fed has thrown into the presidential campaign.

Now, there’s little doubt that the majority of Fed governors would like to raise rates. Recent comments by Fed leaders, including Chair Janet Yellen, strongly suggest that they’re leaning back toward the rate-hiking posture adopted last fall but suspended for the first half of this year. As Personal Finance Chief Investment Strategist Jim Pearce wrote last week and Profit Catalyst Alert’s Linda McDonough reiterated this week, strong employment gains in recent months make a rate hike much more likely. This week’s consumer spending report, showing an increase for the fourth straight month in July, further bolsters the case that inflation could pick up soon if the Fed doesn’t act.

But the likelihood is they won’t. They almost never hike rates in the fall of a presidential election season.

In fact, going back eight presidential election cycles, the Fed has raised rates only once in the final weeks before Election Day — in September 2004.

Ironically, if the Fed waits until December to hike rates, inflation might already be picking up – prompting yet another hike early next year that would throw economic headwinds at the new president just as he or she is getting started.

But the Fed chiefs may not be looking beyond the short term. Their concerns about their reputation could very well trump (ahem) economic reality in September, leading the Fed to stay put even if that’s not the right move.

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