Today's Headlines: The Fed Defers Yet Again

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Today's Headlines:  The Fed Defers Yet Again
September 22, 2015

To Raise or Not to Raise, That Was the Question

It may not have been a Shakespearean decision, but the Federal Reserve faced an important decision last week. Should interest rates be raised, or kept at the current near-zero level? With apologies to Shakespeare, apparently 'tis nobler in the mind to suffer the slings and arrows of outrageously low interest rates — for a least a little while longer.

The Fed chose not to raise rates, citing continued weakness in the global economy and "concerns about growth in China and other emerging market economies." In her opening statement, Federal Reserve Chair Janet Yellen included the strength of the dollar, volatility in equities, the drop in oil prices, and the widening of risk spreads as monetary tightening factors that are decreasing the need for a rise in interest rates. While Yellen says these factors are transitory, they are still "likely to put further downward pressure on inflation in the near term."

Many economists were expecting the Fed to hold off given recent events, but the dovish language surprised most and left them wondering what the criteria really is to raise interest rates. Inflation is not expected to meet the 2% target mark until 2018, and Yellen remarked that the Fed "judged it appropriate to wait for more evidence, including some further improvement in the labor market, to bolster its confidence that inflation will rise to 2%."

Given that Fed inflation estimates are continually revised downward, what evidence will be convincing enough to predict inflation confidently in over two years from now?

A Broken Connection

The Fed's connection between the labor market and inflation/interest rates doesn't seem to apply in the current climate. University of California-Berkeley economist Dr. James Wilcox rightly points out that during the Great Recession, inflation fell less than expected, while during the recovery, it has increased less than expected. Dr. Wilcox conjectures that the economy heats and cools quite slowly, and that rates have to be raised in advance of true inflation.

However, if the Fed's economic models continually overstate inflation, how do they possibly know when the time is right to act? As Fed Vice Chairman Stanley Fischer said, if the Fed waits until it's absolutely certain to act, it will probably be too late.

In 2012, the Fed announced plans to keep near-zero interest rates until unemployment dropped below 6.5%. We are almost a year and a half past that threshold. Typically, wage growth and economic growth would begin to produce inflationary pressures as unemployment approaches 5%, yet we are stuck with continual slow growth. Wage growth simply has not climbed in proportion to the drop in unemployment, making it difficult for robust economic growth to follow suit in a consumer-driven economy.

Current Fed projections are for unemployment to stabilize at 4.8%, a figure that is lower than the previous standard for full employment and slightly above the pre-recession levels of 4.4%-4.7%. The remaining 0.3% of a drop may not be enough of a catalyst to restore the normal rules, if for no other reason than the U-6 unemployment numbers including underemployed and marginally attached workers remains high at 10.3%.

It may be time for the Fed to de-emphasize the unemployment aspect of the target and consider that we may be entering a new normal, with a semi-permanently enlarged slack pool of employers that keeps across-the-board wage pressures from taking effect.

Market Disapproval

Market reaction to the announcement seemed as conflicted as the Fed governors themselves. Stocks rose after the announcement, then settled back down to end the day slightly down. Upon a day's reflection, the markets signaled disapproval with decreases across the Dow Jones Industrial, S&P 500, and NASDAQ ranging from 1.4-1.7%.

To some extent, the Fed can’t win. Fail to raise rates, and markets sink on the collective economic weakness. Raise rates, and markets may well fall due to increased borrowing costs. The market right now is asking for some form of normalcy, and while the Fed can't do much about the global economic picture, it can at least provide clearer guidance.

In short, the Fed seems to be in a phase of paralysis by analysis. They keep looking for clearer signs of upcoming strong economic growth that simply aren’t there.

Maybe Next Time

With only two meetings left in the year, one in October and one in December, 13 of 17 Fed officials still expect that a rate increase will be warranted before the end of the year. That's down from 15 of 17 in the June meeting, but still a pretty solid consensus.

Momentum is building to raise rates, labor figures and overseas growth concerns be damned. The President of the Richmond Fed, Jeffrey Lacker, made good on his threat to cast a dissenting vote. Other Fed officials, including Atlanta Fed President Dennis Lockhart, had publicly endorsed a rate hike in September.

It's unlikely that the Fed will get any clearer direction from economic news between now and the end of the year, so the battle may be between the more data-driven Fed officials and those who argue that the market has been distorted by long-term near-zero interest rates long enough and the revision process must begin soon.

The Takeaway

By now, analysts and investors may be starting to feel like Charlie Brown, whiffing as Janet -- sorry, Lucy -- pulls the economic football away again. The market has been anticipating an interest rate hike for so long that the reaction to a hike may be an anti-climactic sigh of relief that normalization has begun.

Arguably, the market has been distorted with constant low rates, leaving equities as the only place to make significant returns. It probably is time for the Fed to not only raise interest rates and start to normalize fiscal policy, but also to reconsider whether some long-held economic assumptions about fiscal policy are still valid.

As an average long-term investor, nothing in the Fed announcement should change your plans — and that will likely be true when the Fed does raise interest rates, whether it is in October, December, or 2016. They have telegraphed a very gradual increase, and nothing to date indicates a change in that philosophy. Keep a steady course through the choppy waters, and keep your portfolio in the proper risk balance that works for you.

Looping back to Shakespeare, the quote of the day may have come from the founder of the Vanguard Group, Jack Bogle. In dismissing the current volatile market, Bogle drew on Macbeth by calling the volatility "sound and fury, signifying nothing." Second place goes to Leslie Josephs of the Wall Street Journal: "Make your investment choices and stay the course. Don't do something, just stand there."


Photo ©iStock.com/traveler1116

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Daniel Dohlstrom | 09.22.15 @ 16:03
Have to wonder if the back and forth yes and no about the increase is not done on purpose
Beverly | 09.22.15 @ 16:03
It seems we've been waiting forever for the Fed to raise rates, that I agree with the article that if it does happen it will almost be anti-climatic in the response.
Sarah | 09.22.15 @ 16:04
Well, that's that then. Now to wait and see.
Steffanie | 09.22.15 @ 16:05
At some point it will have to go up, just not sure it will help when it does.
Jackie | 09.22.15 @ 16:05
I feel it's time for the Feds to raise interest rates.
Christina | 09.22.15 @ 16:08
This has been such a long, drawn out process that it's not even news anymore.
Bobbie | 09.22.15 @ 16:08
They need to raise it and let free market sort it all out.
trish | 09.22.15 @ 16:12
It seems to be a waiting game. I think everyone should keep what they are doing
Stokes | 09.22.15 @ 16:13
I'd like to say I'm surprised about this, but that wouldn't be true.
Erin | 09.22.15 @ 16:17
These low rates can't last forever, right? People are going to be upset no matter when they rise.
Nancy | 09.22.15 @ 16:20
The financial world seems like a big jigsaw puzzle with virtual pieces that continually change.
Irene | 09.22.15 @ 16:23
Rates always go up it's just a matter of when.
Tina | 09.22.15 @ 16:28
Like the article says, when they finally do raise the rates it will be very ant-climactic. It's like the boy who cried wolf...
Katie Greene | 09.22.15 @ 16:30
Well, we will see what will come from this. It's always interesting to see the real world changes that make it down to the little people like us
Zanna | 09.22.15 @ 16:38
Everything is wait and see right now. I predict a change closer to the election. It's not time yet.
Christina | 09.22.15 @ 16:40
I hope they don't raise it to high all at once. Most people are just now getting there head above water from the last big one.
Angie | 09.22.15 @ 16:54
It almost seems to have become a game.
Jo Ann | 09.22.15 @ 16:56
With low interest rates people are starting to spend more, Interest rates will rise again its just a matter of when. Purchasers need to enjoy this low interest, because it won't last forever.
George Middleton | 09.22.15 @ 16:57
Sound like they need to look at the budget. They don't know if it's time to give or take.
Steven | 09.22.15 @ 16:57
Wish I could say it surprises me.. but it really doesnt.
Sara | 09.22.15 @ 16:57
Cannot say I am surprised. However, it seems like the should by now.
Heather | 09.22.15 @ 17:15
Why is it taking them so long to make a decision on raising the rate? I wish they would just finalize it and get it over with.
Britt | 09.22.15 @ 17:25
I think it's time that the % gets raised. I feel it's over due
Kathryn | 09.22.15 @ 17:26
It's taken them this long? NOW they want to improve our economy.
Kyle | 09.22.15 @ 17:29
Quite interesting that the rates havent been raised as of yet
Kailie | 09.22.15 @ 17:32
Lots of interesting information in this article.
Morgan | 09.22.15 @ 17:34
Lots of interesting information here.
Angie Taylor, Insurance Agent in Montevallo, AL | 09.22.15 @ 17:37
Interesting. I think the rates need to be raised.
Elaine | 09.22.15 @ 17:43
Been expecting it to go up. Actually shocked it has taken this long.
Jennifer Sears | 09.22.15 @ 17:53
We'll see what, if anything, actually happens.
$commenter.renderDisplayableName() | 12.03.16 @ 00:23
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