The Fed might be raising rates too late
Andrew Harnik/AP
I think there is a mixture of political bias and legacy-building that is driving Federal Reserve policy. The simple fact is that the Fed should have been normalizing interest rates starting in 2013.
Fifty basis points a year, and we would be at 2% now. That is not exactly a torrid rate-hike path. It cannot be seen as putting your foot on the brakes. It’s simply moving to normalize a situation that everybody realizes is abnormal.
I think that everyone on the FOMC recognizes that rates do have to be normalized, and they don’t want to leave the Committee with rates sub-1% as their legacy.
Making up for past mistakes before leaving
It’s a simple fact that for four years during a Democratic administration, they basically refused to raise rates. They said their actions were data-dependent and that the data was telling them it was too early to tighten.
Then Donald Trump gets elected, and all of a sudden the data is telling them it’s time to raise rates.
After they have blown a series of bubbles with their low rates—in housing, stocks, all sorts of debt instruments, the automobile market, markets of all sorts—now somehow the data is different, and we have to raise rates.
No two ways about it: There is no significant difference in the data today from that of four years ago—except that four years ago, we didn’t have all the bubbles. And we are already late in the cycle.
And—the elephant in the room—we now have a Republican president who is not going to reappoint these governors.
How convenient
Unemployment was low four years ago, and it is lower now. The Fed keeps talking about wage inflation, but there is no evidence of it. Plus, the Fed’s models are backward-looking and based on historical economic trends and patterns that no longer exist.
The FOMC members are now figuring that leaving the Committee without normalizing rates is going to be disastrous for their legacy, whatever that is. And so they are going on a tightening cycle.
And they no longer have to worry about creating a recession during a Democratic administration. How convenient. They would aggressively deny that any such thing would ever be part of their decision-making process.
As David Rosenberg has pointed out, Fed tightening cycles always end with a US market crash or an emerging-market crash or both (but usually just a US market crash). The Fed keeps tightening until we get an unpleasant event.
You really can’t ignore the fact that the FOMC is telling you they are going to raise rates at least once more this year. I know that the two-year bond doesn’t believe that, but I think you need to take it very, very seriously.
And I would bet on a January rate hike, in the last month of Yellen’s chairmanship. Doesn’t quite get us to 2% rates but… close enough for government work.
They are hoping that by raising rates slowly, they won’t push the economy into a slowdown before they can abandon ship. Then the next chairman and the Fed can deal with it.