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Current Views

Pause Before Launch?

At this point, it’s well established that the Federal Reserve is “data dependent”. We have all been aware that removal of the extraordinary monetary accommodation is only going to happen after a strong set of economic releases. 

The recent stock market re-pricing was met by a comment from Apple’s CEO, Tim Cook, saying that there continues to be “strong growth” in China for Apple’s business [1]. Cook’s comments remind us that there is a real economy out there, sometimes divorced from the financial markets. While the stock market has declined, at the same time, auto sales, real estate prices, truck and rail utilization, and industrial production all continue to show strength. Revised second-quarter GDP grew at 3.7%. In our view, numbers such as those do not typically justify zero rates. 

So what about market conditions? Should they cause the Fed, seven years into a zero interest rate policy, to hold rates zero-bound any longer? Federal Open Market Committee Vice Chairman (and New York Fed President) Bill Dudley indicated that a rate rise in September is now “less compelling”, though the rest of his statement did not box him into a firm commitment not to raise rates [2]. We think it’s hard to imagine that he might have made such a statement without a nod from his ally, Fed Chair Janet Yellen. 

Clearly, when the Fed does lift rates, it's going to make headlines. While markets have long expected and priced in an increase in the Federal Funds rate, the Fed views the action as one of substantial importance. Given that, they probably want as much justification as possible for the action, especially as it’s likely to set the stage for a series of (we think likely small and gradual) moves. The Fed is not eager to begin this process in the midst of tumultuous financial markets. The thinking being, if we have already waited seven years, what are a few more weeks?   

The “we can wait, what’s the hurry?” logic has, of course, been played before. Yet perhaps with unemployment at 5.3%, they have waited too long already. If the conversation was about raising rates from 2%, we think this might be more debatable, but our question right now is: with these data points, what is the rationale for rates remaining at zero? Even with a below-than-hoped-for inflation rate, we do not believe that by itself is enough to justify zero rates.  

Civilian Unemployment Rate [3]

That does not appear to be how the Fed is thinking. We believe this signals that we are not just “data dependent”: the Fed may also require stabilization of equity prices, some retracement from the declines (which we may indeed have), some leveling off of credit spreads, and the dollar to not appreciate much further. This is a tall list, significantly beyond domestic economic considerations, which by themselves appear positive. 

 Yes, with the depreciation of so many emerging market currencies, the stronger trade-weighted dollar will generate less net exports and, therefore, a lower U.S. growth. We think this also means it’s likely that even less inflationary pressures will appear going forward. But to us, that should not alter the case to launch and begin raising rates a token amount toward an overall path of normalization. 

 


[1] CNBC

[2] GlobeSt.

[3] FRED, shaded areas indicate U.S. recessions.



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