FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
March 15, 2016
Will The Fed Raise Rates Tomorrow? Probably Not
IN THIS ISSUE:
1. Fed in a Tough Spot as Inflation Ticks Up to 2.2%
2. The Fed Has a Real Dilemma on Its Hands Now
3. Abolishing Cash – Stratfor’s Latest Analysis
4. Conclusions – Abolishing Cash
Abolishing Cash – Overview
The Federal Reserve’s policy setting body, the Fed Open Market Committee (FOMC), is meeting today and tomorrow, and there is widespread speculation over whether or not the Committee will vote to raise the Fed Funds rate a second time since lift-off in December.
Late last year the Fed signaled that it intended to raise the Fed Funds rate four times in 2016, most likely at the March, June, September and December FOMC meetings. Yet the Fed could not have anticipated the global stock market debacle that ensued at the beginning of this year and into February.
Given the large and unexpected global equity sell-off we saw in January and early February, most Fed-watchers recently concluded that the FOMC would abandon its plans to hike rates four times this year. Many even speculated that the Fed might reverse course and lower the Fed Funds rate back to near zero. Some even suggested the Fed should implement another round of quantitative easing (QE).
I have been among those who have suggested the Fed should delay any further interest rate hikes until the economy shows more signs of improvement. However, a recent economic report will make it much harder for the Fed to delay another rate hike tomorrow. That will be our main topic today.
Following that discussion, I’ll have more to say about negative interest rates, the War On Cash and a summary of Stratfor.com’s latest analysis regarding this very concerning global trend. Let’s get started.
Fed In a Tough Spot as Inflation Ticks Up to 2.2%
For the last several years, the Fed has maintained that its “core” inflation (minus food and energy) target is 2.0%. Somehow, the Fed believes that we need 2% inflation to have a healthy economy. Yet core inflation has consistently remained well below the Fed’s 2% objective – that is until the February Consumer Price Index (CPI) report from the Department of Labor. On February 19, the DOL reported that core CPI rose 2.2% in the 12 months ended in January of this year. Notice the final number (bottom right) in the DOL inflation chart below.
Think about this. The Fed has been predicting that core inflation would rise above 2% any day now for the last several years. They used this inflation prediction as a rationale for ending QE in late October 2014. They used it as justification for the first Fed Funds rate hike in December, even though core inflation was nowhere near the Fed’s 2% target.
Yet while core inflation has failed to reach the Fed’s 2% prediction repeatedly, we are now there – actually above there at 2.2% – at least according to the latest Labor Department CPI report in February, which showed core inflation at 2.2%.
At this point, I should add that the Fed’s favorite measure of inflation is not the Labor Department’s Consumer Price Index. The Fed prefers to monitor another indicator of inflation called the Personal Consumption Expenditures Index (PCE), which is produced by the Commerce Department as a component of its periodic reports on Gross Domestic Product.
The PCE consists of the actual and imputed expenditures of households and includes data pertaining to durable and non-durable goods and services. It is essentially a measure of the prices of goods and services that we all consume. While the PCE is slightly different, it trends very closely with the CPI.
The latest data for the PCE is for January and was released on February 26. The core PCE (again less food and energy) rose 1.67% for the 12 months ended January. So while core CPI rose 2.2% over the last 12 months, core PCE remained under the Fed’s target of 2%.
While the Fed’s preferred PCE measure of inflation has not yet reached the Fed’s 2% threshold, the trend has indeed turned higher, and it presumably will not be much longer before it crosses into the Fed’s target zone of 2%.
The Fed Has a Real Dilemma on Its Hands
So the Fed has a dilemma on its hands as the FOMC convenes this week to make a critical policy decision. On the one hand, the stock market rout earlier this year would suggest that the Fed delay any further interest rate hikes until later this year, although most global equity markets have recovered much of the January/February losses.
On the other hand, with core CPI up 2.2% in the last 12 months, and with core PCE clearly headed toward the same level, the Fed may feel compelled to raise rates a second timetomorrow in an effort to keep inflation from moving above its target of 2%.
Since the stock market plunge in January, several Fed officials have gone on record saying that a second Fed Funds rate increase should be delayed, perhaps indefinitely. But that was before the February 19 DOL report showing that January core CPI rose 2.2% over the last 12 months.
The Fed believes it has a mandate to keep inflation near 2%. But it also believes that it has a mandate to keep the economy (and I would argue the equity markets) growing. So it will be very interesting to see what the Fed decides tomorrow.
I believe that if the Fed raises rates again tomorrow, it will have another very negative effect on the US and global equity markets. The US and global equity markets are hooked on Fed easing and extremely low short-term interest rates.
At this point, I’m supposed to make a prediction on what the Fed will decide tomorrow. The truth is, I don’t know but I will make a prediction anyway. Fed Chair Janet Yellen is a “dove,” meaning she is less likely to make tough decisions.
So my prediction is that the Fed will delay another rate hike until the June 14-15 FOMC meeting or even later. But I could be wrong. We’ll see.
In any event, we’ll know what the Fed decides tomorrow afternoon. If there are any surprises, I’ll address them in my blog on Thursday. If you haven’t subscribed to my free blog, CLICK HERE.
Abolishing Cash – Stratfor’s Latest Analysis
I have written in recent weeks about the ramifications of negative interest rates and the ongoing war on cash. Negative interest rates impose a tax on savers who will have to pay a fee to park their savings at banks.
The war on cash is intimately related to negative interest rates as I will discuss below. There are movements afoot in Europe and elsewhere to eliminate large currency bills such as the 500 Euro Note and even calls (from liberals) to get rid of