Sunday, May 10, 2015

Will the Federal Reserve Ever Raise Interest Rates?

By Robert Wenzel

Their are a number of peculiar ideas circulating within the Austrian school and near-Austrian school economics community.

One idea holds that the Federal Reserve  will never raise interest rates, another holds that the Fed will soon embark on a new round of Quantitative Easing.

Neither perspective, in my view, fits with reality. A rate hike is coming and it is coming soon.

The perspective of the opposing view is reflected in a comment left at a recent EPJ post, where I linked to an interview with Political Badger, where I state that the Fed will soon raise rates.


The comments reads:
Robert, in the interview you say that the Fed is telegraphing it's game plan and if you simply read what Yellen et al. are saying you can understand when they will raise rates. But hasn't the Fed already moved the goal posts that it is using to make that decision on multiple occasions? Why should we believe the data dependent points now?
The idea that the "Fed is moving its goal posts" is simply a myth perpetuated by mainstream media. The Fed's troika, of Federal Reserve Chair Janet Yellen, Vice-Chair Stanley Fischer and New York Federal Reserve President William Dudley, is making it very clear as to what the Fed is looking for in terms of economic numbers that will result in a rate hike.

The transparency the Fed is providing as far as what they are looking fo is simply stunning. It is probably partly the result of fears that "audit the Fed" will gain more traction.The other reason is that they want to prep markets to the rate hike before it occurs.

I carefully review the speeches of all Fed members, but it is the speeches of the troika that are most important. And there has been a remarkable step by step, progress of disclosures as to exactly what the Fed is looking for in the data that will cause them to raise rates. I report on the comments of the Fed speeches in the EPJ Daily Alert.

On March 31, I wrote in the ALERT:
It is difficult to understand how some Fed observers believe that the Fed will not raise the Fed funds rate until the December FOMC policy meeting. The Fed has been spoon feeding the markets what they are looking at in terms of economic data, before they start to raise rates,and what they are looking at is chiefly the unemployment level .

During Fed vice-charirman Stanley Fischer's speech on March 23, he said this:
The unemployment rate, at 5.5 percent in February, is nearing estimates of its natural rate, and we expect that inflation will gradually rise toward the Fed's target of 2 percent. Beginning the normalization of policy will be a significant step toward the restoration of the economy's normal dynamics, allowing monetary policy to respond to shocks without recourse to unconventional tools.
A few days later Fed chair Janet Yellen on March 27 took it one step further in a speech by providing an exact range the Fed considers the "normal" unemployment rate.:
The unemployment rate has fallen markedly over the past few years and now stands at 5.5 percent, down from 10 percent at its peak. Payroll gains have averaged 275,000 per month over the past year, well above the pace needed to sustain further declines in the unemployment rate. Of course, we still have some way to go to reach our maximum employment goal. The unemployment rate has not yet declined to the 5.0 to 5.2 percent range that most FOMC participants now consider to be normal in the longer run.
In the April 20  ALERT, I wrote:
 New York Federal Reserve President William Dudley spoke this morning at the Bloomberg Americas Monetary Summit in New York City. The speech was significant for two reasons, it laid out again what the key Fed policymakers are thinking  and he issued another warning about the Fed hikes that are coming.

Specifically Dudley said that "despite the weak performance of the first quarter, I believe that the growth prospects for the U.S. economy over the remainder of 2015 will improve.  I expect that the first quarter weakness will prove to be largely temporary."

This is in line with the recent comments of another member of the Fed policy troika, Vice-Chairman Stanley Fischer. Dudley did also indicate that like all Fed members he is simply a data watcher, "The timing is data dependent.  We will have to see what unfolds."

And he focused, like Fed Chair Yellen and Fischer, on two factors the unemployment number and price inflation.

With regard to unemployment he said, "My outlook for 2015 as a whole is that economic growth will be close to the pace of the past two years, supported by continued solid fundamentals and accommodative financial conditions.  If I am correct, then this would lead to a further reduction of labor market slack, with the unemployment rate approaching 5 percent by the end of the year. "

Fischer in recent speeches has signaled that the Fed will consider it time to raise rates when unemployment is in the 5.2% to 5.0% range. The current unemployment number (for March) is 5.5%....

As for inflation, Dudley stated that  "the data continue to come in below the FOMC’s objective of a 2 percent annualized rate for the personal consumption expenditures (PCE) deflator.  The twelve-month change of the total PCE deflator was just 0.3 percent in February, with the core PCE deflator at just 1.4 percent.  Despite these low readings, my expectation is that inflation will begin to firm later this year.  Importantly, most of the impact from the decline in energy prices that has weighed down overall inflation is likely over. 

"If this labor market improvement continues and the FOMC is reasonably confident that inflation will move back to our 2 percent objective over the medium term, then it would be appropriate to begin to normalize interest rates."

Note again: This is completely in line with Yellen-Fischer, they are NOT going to wait for price inflation to hit their  2% "target." All they want to see is inflation trending upward.

On May 1, I wrote in the ALERT:
 I am keeping most of my fed watching focus on the troika of Fed Chair Janet Yellen, Vice-Chair Stanley Fischer and NY Fed President William Dudley, but in remarks this morning, Cleveland Fed President Loretta Mester made a number of points that are in line with the troika. It's not something you necessarily see from the Fed presidents of other hinterland districts.

She said that the Federal Reserve is getting close to the appropriate time to raise interest rates and all scheduled policy meetings, including the one in June, are "on the table" for a move,.

She told reporters, after a speech on consumer credit at the Philadelphia Fed, that the decision will hinge on incoming economic data and, in particular, on employment reports for the months of April and May.

She said most of the weakness in some data was "transitory."

And she noted,"There are a whole bunch of data releases that will come out between now and June. But to me the employment reports will be indicative of a lot."

I could go on, but the point is clear. The Fed is not going to wait for price inflation to hit its 2% "target," before they raise rates.  As long as they believe inflation is trending toward 2%, they will feel justified in raising rates. They are watching the unemployment rate, and it appears that the target range for raising rates is when  unemployment drops to the 5.2% to 5.0% range.

The unemployment number for April just came in at 5.4%. Unemployment has been displaying a major downward trend.


It is a very strong possibility that the unemployment rate will fall to the 5.2% level, or lower, this summer.

There are three Federal Reserve FOMC monetary policy meetings this summer:

June 16-17
July 28-29
September 16-17

I expect it a very likely that the Federal Reserve will raise rates during this period.

In Friday's ALERT, I wrote:
When Will the Fed Act?

Bottom line: The employment data, which the Fed is watching very closely, continues to inch towards the 5.2% to 5.0% range that Yellen-Fischer-Dudley have indicated is the range they want to see before they raise the Fed Funds rate and the rate paid on excess reserves.

The market still doesn't seem to get this.

Odds implied by Fed fund futures showed traders see a mere 7% chance the Fed will raise rates in July, never mind June. September odds are at 22%, October odds are  down to 38%, and December odds to 55% .

My take goes this way: 

June rate hike chance: 20%

July rate hike chance:  35%

September rate hike chance: 35%

Later than September 10%
There is very little likelihood that the Fed is not going to raise rates soon. The question is not IF but WHEN.

The Fed is being somewhat proactive in their consideration of a rate hike. Often, the Fed doesn't raise rates unless it is "forced" to by climbing price inflation. I expect the price inflation to come and that will force the Fed to raise rates again and again. But, as I say, that first rate hike is going to be pro-active before the price inflation gets serious. Nevertheless, even if they weren't being proactive, they would eventually be forced to raise rates anyway because of accelerating price inflation. The idea that there are not going to be any rate hikes flies in the face of current thinking by the Fed troika and the accelerating inflation that will eventually put pressure on the Fed to raise rates.

The rate hike itself will be a hike from the current Fed funds target range of 0.0% to 0,25% to the 0.25% to 0.50% range. The rate paid on excess reserves at the Fed will be raised from 0.25% to 0.50%. But this will be just one rate hike. It won't be the type of stepped rate hikes that we have seen in the past. For example, during part of the period when Alan Greenspan was chairman:


It, though, will not be a "One and done" rate hike by the Fed. It will be a "One and watch" rate hike. The Fed is going to make that first rate hike and then watch to see what it does to the stock market and economy.I believe ultimately more rate hikes will occur and they will be forced on the Fed by accelerating price inflation.

As for the idea that we are somehow currently spiraling in some kind of downward loop in the economy. There is no evidence of such. As can be seen from the unemployment chart above, We are in a multi-year decline in the unemployment rate, Yes, the government numbers are fudged at the edges, but there is no indication that the government is currently distorting the overall downward trend in the unemployment rate. The downward trend is real. Much private sector data confirm this fact.

Activity in Silicon Valley and overall stock market performance confirm we are in the boom phase.


This is not to say that things won't end badly, they will. This is a Fed manipulated boom that can't last. It is typical Fed induced boom-bust business cycle activity. But to deny that these manipulated boom periods don't occur is really to deny the basic fundamentals of Austrian School business cycle theory,

Robert Wenzel is Editor & Publisher at EconomicPolicyJournal.com and at Target Liberty. He is also author of The Fed Flunks: My Speech at the New York Federal Reserve Bank. Follow him on twitter:@wenzeleconomics

22 comments:

  1. Nobody knows what the fed will do, including the fed. When you are dealing with mental malfunction of this magnitude, all bets are off.

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  2. I got into a back and forth discussion with a guy who agrees with you. Ultimately, I wagered 10 oz. of silver that there will be no rate hike this year. He thought there would be one this spring- that got kicked down the road. like you, he is now banking on September.

    It's not going to happen or if it does- it will be a nominal increase- maybe just a face saving .25 or .50. The only policy tool the FED cabal has left is jawboning. If you think those carefully choreographed for public consumption meeting minutes mean anything- you are wrong. Rate hikes mean higher bond interest, remember we have an 18.2 trillion dollar debt- at least half of which has been refinanced into the shortest maturities. A couple of percentage points and VOILA- we won't be able to service the debt and the whole thing goes supernova.

    Never pay attention to what anyone says- always pay attention to what people do.

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  3. A whiff of momentary sanity from the monetary gods at the Eccles Building is too much to hope for when they are continually behind the curve when turns in the economy appear. That being said, I have maintained since January 2010 that they could not raise interest rates, and the have not up to this point. It appears to be a matter of whether they are more concerned with the all time high in the number of people not in the labor pool, or competition from a quickly evolving Yuan trading block. To me the government is preparing for war in Ukraine and the middle-east involving Syria, and Iran, and will do what is most effective in bleeding the American middle class of it's last ounce of monetary reserves. I do not have the answer but, I know instinctively that the answer will be found in what is most effective in destroying hope, and sanity on a monumental scale.

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  4. Excellent explanation of the current day and probable future.

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  5. Thank you Robert for clearly explaining what is going on. I saw a lot of the trends, and knew your predictions. This post put them all together for me.

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  6. On what planet is 2.9% real GDP growth a boom? Real GDP growth is broken down into population growth, productivity growth and change in the employment to population ratio. Monetary policy only impacts the later and during the past 12 month's it has increased only .7%. Population grew .74%, employment to pop grew .7% and productivity grew 1.5%. Productivity growth is typically around 2%. The economy is under a constraint, not booming. What happened to the argument that regulations were choking the economy? Now it's booming? LOL, guess it depends on what govt policy people want to criticize.

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  7. Given the numerous problems and distortions in the labor market, basing Fed rate hike policy on the unemployment rate being in the 5.0-5.2% range is ludicrous. Fed timing will probably be based on the political cycle more than anything else.

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  8. Like it matters.
    "Tomorrow I'll smoke marginally less PCP."

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  9. Thanks for the post Robert. Rates will have to rise eventually, of course and I think you're analysis of the trends is spot on. It just seems to me that the Fed will say what it needs to in order to keep the markets under control. Correct me if I'm wrong but earlier last year did the Fed not set a 6.5% unemployment rate as one of the data points they would wait for before raising rates, and then lower the target once it was clear the economy couldn't handle higher rates at that point? Couldn't that happen again? I'm just trying to reconcile your stance with someone like Peter Schiff.

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    1. That was a target set by Bernanke, not by Yellen-Fischer-Dudley. It was removed by Yellen-Fischer-Dudley after Bernanke left. Yellen-Fischer-Dudley are in charge and they have made their target clear.

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    2. Interesting. Good to know.

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  10. No*

    If they do, asset prices will plunge causing impending systematic failure. The Fed will undue the raise and announce a new tranche of QE.

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  11. Interest rates need to rise. They need to rise dramatically to offset years of monetary insanity.

    But even a small rate hike is going to crater the stock market. Housing will tank again. Non-performing loans would push most banks into insolvency.

    Further, every one percent increase in rates means $180 billion in extra debt service costs at the federal level, with more at the state and municipal level. Unemployment would skyrocket, and no amount of BLS manipulation would hide the damage.

    In other words, a small rate hike does nothing to stop the bleeding. A large rate hike causes a major depression and possibly a government default.

    Of course, a reset is what is required to destroy the phony economy that has been built for decades. The hollowing out of our manufacturing base and the complete financialization of the economy cannot last.

    In my opinion, any rate hike will be meaningless and would be reversed in short order. The "markets" cannot last without ZIRP and QE. We'll see QE4 in 2016. Suffering a depression during a presidential election year won't be tolerated.

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    1. State and local governments are under pension pressures more than debt service pressures. Increased interest rates would probably do more good than harm at that level. Sure debt service would get worse but the pension obligations would be diminished.

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    2. Steve,
      I have brought up these exact same issues with Robert since he first began to call for rising interest rates back in the spring of 09'. I have never had a response from him in this comment section or in direct emails.

      If the FED raises rates from the 0%-.25% range by as little as a quarter point and never raises rates again, I am sure Robert will let us all know that he was right on his call for a rate hike. Much in the same manner as he did with the bitcoin failure.

      Alan

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    3. You have got to be kidding me. Wenzel's warning on Bitcoin saved me $60,000. I got out at $700. That is the best warning I ever received.

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    4. "You have got to be kidding me. Wenzel's warning on Bitcoin saved me $60,000. I got out at $700. That is the best warning I ever received."

      Yeah. I don't get Alan's beef with RW on bitcoin since it did tank like a rock. Glad I stayed out of it.

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    5. It also appears that Alan has a reading comprehension problem. Wenzel makes clear there will be more that one rate hike:

      "It, though, will not be a "One and done" rate hike by the Fed. It will be a "One and watch" rate hike. The Fed is going to make that first rate hike and then watch to see what it does to the stock market and economy.I believe ultimately more rate hikes will occur and they will be forced on the Fed by accelerating price inflation."

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  12. "The idea that the "Fed is moving its goal posts" is simply a myth perpetuated by mainstream media."

    "They are watching the unemployment rate, and it appears that the target range for raising rates is when unemployment drops to the 5.2% to 5.0% range."

    The changing goal posts is not a myth perpetuated by the mainstream media, it is what the Fed is actually doing. The original unemployment "benchmark" laid out by Bernanke in December 2012 was the rates were going to remain low, and they would begin normalizing them when unemployment hit 6.5%. 6.5% was the original number (http://www.usatoday.com/story/money/business/2012/12/12/fed-buys-treasuries/1762459/). We're way past that number.

    The unemployment rate is largely coming down because people are dropping out of the labor force. Any jobs that are being found, are crappy low-paying jobs, which is why wages haven't budged in ~6 years. With the recent awful trade data (among other data) likely pushing Q1 GDP into negative territory, and a string of two disappointing jobs numbers... I simply cannot see how the Fed would raise interest rates in that kind of economic data environment. Anything is possible of course, but I continue to see it as highly unlikely.

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  13. Great post Bob.

    I think whether or not the Fed does one rate hike is nohwere as significant as what happens post the hike or without the hike. I mean the inflation vs. deflation debate among Austrians is way more important and interesting and I hope champions like you will help honestly discover the possibilities.

    I know you are somewhat in the inflation camp but seems like there is also a reasonable argument for significant (asset price) deflation eg; the one from Harry Dent.

    Will appreciate if opposing camps sit together and calmy discuss the ifs and buts (rather than trying to win the argument).

    Thanks for all that you do for liberty.

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  14. Anything beyond a "ceremonial" hike of 25 to 75 bps is very unlikely. The Fed needs to keep their word that they will raise rates but cannot raise them so much that the liquidity issues in bonds gets worse or debt service burdens become worse.

    The price inflation argument has been "the boy who cried wolf" for years on end now. The data just don't support the idea that price inflation will trend above 2%, initiating a response from the Fed for more rate hikes. Consumers are still deleveraging from the crisis, and wage gains have been minimal at best. Without consumers borrowing to consume in greater quantities, price inflation is unlikely to increase to a level where more Fed action is necessary.

    But, the Fed is notorious for messing things up. I wouldn't be surprised if they went against the wind and blew everything up ... again.

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  15. It makes sense to raise rates now in the ass end of Barry's regime and let him take the political flak rather that start the Empress's or Bush's reign with a major crisis.

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