Odds are that US Interest Rates will be back to Zero within 6 months

So it seems the tea leaves in the empty tea cups at the Fed’s recent planning meetings point to the first interest rate hike in 9 years.  The pundits are saying the Fed will raise rates at their regularly scheduled meeting Wednesday this week.  Something like 70-90% of polled economist’s seem to agree.  But hang on a tick – there are a few data points worth calling out:

  • Little has changed globally & economically since September, when the Fed decided against a raise that had been widely expeceted just a month before; Agreed, US economic data in terms of employment has improved slightly and job growth (albeit low wage) is still improving, but…
  • Inflation is stubbonly low (commodity prices globally remain depressed and showing little sign recovering).
  • Wage growth is weak, with only initial signs of a slight uptick recently.
  • The dollar is already quite strong and raising rates will only make it stronger, attracting funds from overseas, thus making US exports more expensive, and imports cheaper (worsening the trade balance).
  • The sucking in of foreign funds to dollars will draw investment from emerging markets that will suffer as a result.  This will further hamper global balancing and growth.
  • The actual business cycle in the US seems to be past its natural peak and business profits are falling in more than half of the economy with firms everywhere reporting contraction.  

On any other day and planet, given these conditions, we would not expect to raise rates.  In fact, in “Central Bankers Worry Rate Increase Will Come Undone” (see today’s US print edition of the Wall Street Journal), it seems that a majority of economists polled for the article worry that the Fed will be forced to undo the increase and return to zero:  “[M]ore than half said it was somewhat or very likely the Fed’s benchmark federal-funds rate would be back to zero within five years”.  Admitedly that’s a long time away and does not hint at panic, and probably allows for the backend of the business cycle to work its way through.  But I think, based on the global situation, the market is too sensitive and volvatile.  

My guess is that though we need to raise rates to move the economy toward normalization, the US cannot move in isolation and without coordinating similar moves in Europe or China.  Since those regions are diverging, the US move will just put more stress on what is already a very stressed system.  Some few weeks ago I was calling for a raise in US rates by the middle of 2016.  I still think that would be the right time to align with other large economic regions, assuming they show signs of recovery – and even that is not firm.  So all told, it will be a fun week.  It is hard to call if the market will rally or fall in response to Wednesday’s meeting.  Maybe the Fed hopes the holiday season will give the marrkets time to adapt and consume the increase and avoid any frantic movements.  Whatever happens I think it will still be a volatile week.  Hang on.

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