Fed Keeps Debate Raging: When Will They Finally Raise Rates?

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Thursday the policy setting arm of the Federal Reserve held interest rates near zero for the 82nd month in a row.

The decision to stay-put extends months of debate among policy makers, economists and investors about when the central bank should pull the trigger. Opinions also vary on whether market concerns, global uncertainty and the lack of inflation or improvements in the labor market should be weighed most heavily in the decision.

The reaction to the inaction is sure to be mixed.

Polls have shown economists divided on what the Fed should and would do. And just this morning less than a quarter of futures investors were anticipating a September rate hike, according to the Chicago Mercantile Exchange, down from close to half in early August. Traders use Fed-funds futures to bet on timing and pace of interest rate moves. Currently 16% of futures traders expect a hike in October and 45% expect a hike in December.

“I am hopeful that they will get the ball rolling, ” said Dean Croushore, chair of economics at the University of Richmond and a former vice president at the Philadelphia Fed, in an interview a day ahead of the Fed statement release. “There is always something going on in the economy. You can always point to, ‘O, China is volatile and the financial markets are volatile so we shouldn’t do it.’ Before that it was uncertainty in Europe and Greece possibly defaulting. Next time it will probably the deterioration of some other economy in the world. But you have got to get there eventually.” People in favor of a September hike were also arguing the sooner the committee normalizes policy the more ammo they will have when the next recession hits.

Folks on the hold-tight side of the debate have argued that the recent market downturn both showed that financial conditions are not right to hike and that that mini-crash brought about many of the changes a policy maker seeks when lifting short-term rates. On a more fundamental level, some economists disagree with the Fed’s assertion that factors keeping inflation below target are temporary.
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“If, in fact, policy makers are watching the latest round of US data, a further decline in manufacturing activity, weaker-than-expected headline job creation and consumer spending, as well as another month of waning price pressures as reported this morning should be enough to keep the Fed on the sideline well beyond September,” wrote Lindsey Piegza, chief economist at Stifel Nicolaus & Co in a note distributed Wednesday. “With further global weakness translating into continued downward pressure on commodities and raw materials, US inflation is likely to remain increasingly benign for the remainder of the year and beyond, undermining any notion of confidence inflation will begin to reverse course back towards the Fed’s target of 2%.”

If you take a long view this debate has been going on for years.

The Federal Open Market Committee slashed its target for the federal funds rate to a range of 0% to 0.25% in December 2008 in an effort to prop up the quickly deteriorating American economy. The FOMC has now maintained historically low short term rates for more than six years, judging that the economy was not yet strong enough to handle a tightening in access to funds.

fredgraphAs recently as March the committee left an opening to hike as early as June. By June many pundits argued September still looked reasonable. Then a bout of market volatility in late August brought that timeline into question.

One thing both sides agree on is that today’s decision to hold off doesn’t mean much in itself. Fed Chair Janet Yellen and other FOMC members have consistently said the initial hike will be small — 0.25% — and hikes beyond that would be gradual. Eventually higher short-term rates will impact the how much average Americans pay for a mortgage and the yield they can expect in their savings accounts, but 0.25% will likely bring no discernible change in the short term.

They date the Fed does finally begin to raise rates will be remembered since it marks a major change in strategy, points out Croushore. He says, “In terms of the actual impact on the economy if interest rates are 25 basis points higher that is not really effect much, if anything, in the economy at all.”

Samantha Sharf

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