Fed Set To Pull Trigger Tomorrow – A Good Thing Or Bad? by Gary D. Halbert
FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
December 15, 2015
IN THIS ISSUE:
- A Primer on the Fed Open Market Committee
- The Case FOR a Fed Funds Rate Hike Tomorrow
- The Case AGAINST a Fed Funds Rate Hike Tomorrow
- The Fed’s Dilemma – Crying Wolf Too Often
The Fed Open Market Committee (FOMC) which sets US monetary policy convened in Washington this morning for its last meeting of 2015. It is widely expected that the Committee will vote to hike the key Fed Funds rate for the first time in almost a decade before the meeting concludes tomorrow.
The FOMC slashed the Fed Funds rate from 5.25% in late 2007 to near zero by late 2008 during the financial crisis and recession. It has kept the key lending rate at 0.00% to 0.25% ever since in an effort to stimulate the economy, in addition to buying an unprecedented $3.7 trillion in Treasuries and mortgage-backed securities in a process known as “quantitative easing” or QE.
It is not entirely certain that the FOMC will hike the Fed Funds rate tomorrow, but that is the prevailing consensus. Based on the minutes from the last FOMC meeting in late October, which were released on November 18, it is clear that Fed Chair Janet Yellen has a majority of FOMC voting members ready to support a rate hike if she chooses to do so.
It is also not entirely clear how much the Committee might raise the Fed Funds rate should it decide to enact “lift-off” tomorrow. The prevailing consensus is that the first rate hike would be only 25 basis points (0.25%), but the Fed has provided very limited guidance as to the size of the expected increase. Assuming the rate hike is only 25 bips, the other question is from where – the Fed Funds rate is currently just under 0.15%.
There are strong arguments on both sides of the lift-off issue. Many believe the Fed has already waited way too long to start normalizing interest rates and are adamant that lift-off should begin tomorrow. Many others, however, believe that the economic recovery is still too weak and the Fed should delay lift-off until sometime next year at the earliest.
It is these two arguments that we will discuss today, ahead of tomorrow’s key decision. But before we get to that discussion, let’s do a quick review of the makeup of the Fed Open Market Committee, the most powerful monetary policy body in the world.
A Primer on the Fed Open Market Committee
The Federal Open Market Committee is charged by law with overseeing the nation’s open market operations (ie – the Fed’s buying and selling of United States Treasury instruments and in some cases other securities). It is this Federal Reserve Committee which makes key decisions about interest rates and the growth of the United States money supply.
The FOMC is the principal organ of United States national monetary policy. The Committee sets monetary policy by specifying the short-term objective for the Fed’s open market operations, which is usually a target level for the Fed Funds rate (the rate that commercial banks charge between themselves for overnight loans).
The FOMC also directs operations undertaken by the Federal Reserve System in foreign exchange markets. Any Fed intervention in foreign exchange markets is coordinated with the US Treasury, which has responsibility for formulating policies regarding the exchange value of the US dollar.
The FOMC meets eight times per year (about every six weeks) to set key interest rates, such as the Fed Funds rate and the Discount rate and to decide whether to increase or decrease the money supply, which the Fed generally does by buying and selling government securities.
Today’s FOMC consists of 12 members: the seven members of the Federal Reserve Board and five of the 12 regional Federal Reserve Bank presidents, but only 10 of the 12 members actually vote. The other two serve as alternates if needed.
Five of the Federal Reserve Bank presidents serve one-year terms on the FOMC on a rotating basis. The rotating seats are filled with Fed bank presidents from Boston, Philadelphia, Richmond, Cleveland, Chicago, Atlanta, St. Louis, Dallas, Minneapolis, Kansas City and San Francisco. The New York Fed president always has a voting membership.
The current voting membership of the FOMC includes:
Janet L. Yellen, Board of Governors, Chair
William C. Dudley, New York, Vice Chairman
Lael Brainard, Board of Governors
Charles L. Evans, Chicago
Stanley Fischer, Board of Governors
Jeffrey M. Lacker, Richmond
Dennis P. Lockhart, Atlanta
Jerome H. Powell, Board of Governors
Daniel K. Tarullo, Board of Governors
John C. Williams, San Francisco
The Case FOR a Funds Rate Hike Tomorrow
There are numerous reasons why the Federal Reserve should raise short-term rates at its policy meeting today and tomorrow. While I won’t bore you with all of them, here is a summary of perhaps the most common prevailing wisdom in favor of a rate hike now.
The Fed has held short-term interest rates near zero for seven years now. Normalization of short-term rates has to occur at some point, and the economy seems more than strong enough to handle slightly higher rates.
The November jobs report on December 4, like the October report before it, affirmed the strength of the recovery as once again the US added more than 200,000 jobs to more than absorb new entries into the workforce and help push the nation’s unemployment rate even lower.
Also last week, Chair Janet Yellen said she was “looking forward” to when the Fed “begins to normalize the stance of policy” and that “doing so will be a testament … to how far our economy has come.”
This is classic Fed-speak suggesting that because the economy is strong enough, the Fed needs to begin raising interest rates to head off a new round of price inflation. Yet inflation is nowhere in sight. According to the Bureau of Labor Statistics, consumer inflation is running at an anemic rate of only 0.2% so far this year – not a problem by any stretch.
The truth is that the Fed is desperate to raise rates so that it has some room to cut interest rates to fight the next recession, which it worries may be just over the horizon.
In any event, the Fed wants us to believe that the table is set for the first increase in US interest rates in more than nine years, and should be heralded as a huge vote of confidence in the economy – something that, like Janet Yellen, all investors should look forward to.
Are you buying that? No, I didn’t think so. Me either.
The Case AGAINST a Funds Rate Hike Tomorrow
As we have approached tomorrow’s likely increase in the Fed Funds rate for the first time in over nine years, several groups that rarely agree on anything have coalesced to oppose lift-off at this time. These groups include former Treasury Secretary Lawrence Summers, market monetarists, gold bugs and even some so-called “hard money” activists (ie – conservatives).
Several factors contributed to this meeting of unlikely minds, but one was an article on RealClearMarkets.com last week by Louis Woodhill, a Forbes contributor. Woodhill believes the Fed should target “the real value of the dollar,” but given the