To raise or not to raise interest rates

yourwealthourinterest-1The United States Federal Reserve (Fed) is supposed to control inflation and employment. Typically, the two – inflation and employment – work together. That is, if employment is robust, inflation rises; if employment is not great, inflation falls. However, we have seen employment increase without a corresponding increase in inflation. Against this backdrop, the financial market ,isn’t keen on an increase in interest rates. A hike in interest rates would increase borrowing costs in the US and lead to an increase in the strength of the US Dollar against other currencies, especially the currencies of developing countries.

In order to hit inflation targets the Fed may choose to keep rates stable. However, there is a danger here as some economists, such as Avinash Persaud, point out. One argument is that financial stability is more important than hitting inflation numbers.

“Monetary policy cannot confine itself to reacting to the latest inflation data if it is to promote the wider goals of financial stability and sustainable economic growth. An over-reliance on extremely accommodative monetary policy may be one of the reasons why the world has not escaped from the clutches of a financial crisis that began more than eight years ago,” Avinash Persaud wrote in support of a September rate hike, which didn’t materialize.

I believe that the Federal Reserve wishes to hike in December, due to the holidays. It represents the best time in the next 12 months to do so with reduced market volatility, since traders are often on holiday break and trading volumes are reduced. In addition, what better a time to test if the economy can survive a rate hike than at the busiest time of the year? Under this logic it is likely that the Fed is itching to pull the trigger.

Unfortunately, managing the largest economy in the world is never that simple and the Fed will also be looking at near zero inflation despite all of their quantitative easing (monetary stimulus) as USA CPI
(YoY -year on year) threatens to go below zero per cent. Various commodity indices, average hourly earnings (YoY) and the fourth quarter USD GDP estimates are all heading in the wrong trajectory.

Barring a global crisis or a US domestic crisis I expect that the Fed will see December as the perfect time to raise rates over other months. However, the evidence suggests that doing so is still a coin flip, as there is evidence to suggest that it should raise rates and also perhaps stronger evidence to suggest it shouldn’t. Without getting too caught up in what the Federal Reserve should and shouldn’t do, I would predict that it will indeed raise rates, with only 60 per cent certainty.

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