The Federal Reserve’s next meeting is today and tomorrow, Wednesday September 16th and Thursday the 17th. This event is one of the most anticipated Fed meetings in a generation. Global traders have debated the timing of the first rate hike since the beginning of 2015. The voting members of the Fed are as divided as economists. The debate has played out all year and the uncertainty has caused wild price swings in all asset classes (stocks, bonds, commodities and currencies). At times the wild price swings have hit a hyperbolic state with movements in stocks of greater that 1000 points.
Why the drama? The last time the Fed hiked rates was almost a decade ago. Put another way, the kids that recently started their senior year at high school were in second grade the last time rates were hiked. The Fed dropped rates to zero and embarked on a series of other accommodative measures to kick-start the economy in response to the Great Recession of 2008.
The Fed has two mandates from Congress, full employment and price stability.
Jobs: Hiring is strong and by many measures the mandate is fulfilled. The most recent BLS report showed a downtrend in hiring with 173,000 jobs added versus the expected 220,000 in August. That report did little to provide clarity to future Fed actions. The Fed would like to see wages rise. The middle class has not seen wages rise above inflation since the 90’s. With 67% of the economy driven by consumer spending, a pay raise to the middle class would be beneficial to the overall economy as long is inflation does not get loose.
Price stability is another issue. Inflation has been stubbornly low. Europe is battling deflation. While it sounds like falling prices would be a bonus for consumers, it actually causes them to delay purchasing goods and services opting to wait and see if they can get a better deal later. This causes an economy to contract (lower GDP) and can create a “death spiral” for economic output. One irony the Fed faces is the US dollar. Global commodities are priced in dollars. When the Fed raises rates the dollar will strengthen and commodities will get cheaper, creating a downward push on inflation. In addition, a strong dollar makes imports cheaper further pressuring inflation to the downside.
Other considerations the Fed is facing include China, Europe, emerging markets and the potential for another global recession. China’s economic output (Gross Domestic Product) is falling which is causing pain in many emerging markets. China’s appetite for raw materials such as copper, coal, steel and cement to name a few has supported many other countries that export to them. Many emerging markets such a Brazil have borrowed heavily in US dollar dominated debt because it was cheaper. As the US dollar becomes stronger versus the home currency the cost of the loan rises in the home country. Rising borrowing costs and lower economic output because China is slowing has the potential to cause another market route.
Global traders are not as concerned over the first rate hike. It is what happens next that causes them heartburn. Low interest rates have helped many companies and consumers in the past 7 years. However, at some point the Fed has to take away the punch bowl or another crisis will emerge as bubbles pop.
So, What will happen?
There are predictions galore, but no one really knows what the Fed will do. My personal hope is that they will raise short term rates by .25% and announce that they need to see much stronger economic growth or more specific warnings signs of inflation before moving further. This would give the markets stability – traders will know what the Fed is planning and the “rate increase” will be behind us. There is also a better than even chance that this action would cause a rally in mortgage financing markets leading to lower interest rates.
We will see what happens at 2PM tomorrow – see you then. In the interim, please feel free to give me a call if you have concerns, questions or want advice for clients in the middle of a home financing or purchase decision. We can help.