August was the 80th successive month of the US Federal Reserve standing pat and not adjusting their key policy interest rate known as the federal funds rate. This Wednesday could mark the first rate move since December of 2008. As investors attempt to determine the actions of the US Federal Reserve, this “will they, or wont they” scenario has cast a cloud over the markets for the past few month as the US Fed readies themselves for liftoff. Investors have been essentially at a dead split in terms of their projection for whether the US Fed’s policy setting committee, known as the FOMC, would hike rates; moreover, consensus has now moved to being a little less likely as the market is currently pricing in a 25 per cent probability the Fed hikes this Thursday.
There is a very complex debate taking place for whether the fed should raise interest rates. For starters, the US Federal Reserve has never raised rates in a period when the global economic outlook has such a high level of uncertainty. Even though the argument is more globally based than the Fed’s domestic interests, it still might be the best reason for the Fed remaining on hold.
Harvard Economics Professor and former Director of the National Economic Council to President Obama, Larry Summers is arguably one of the most vocal advocates for why the US Federal Reserve should remain on hold. In a recent blog post he states five reasons for why the Fed should do what is potentially the hardest job for a policy maker, which is nothing. His strongest argument is that hiking rates for sake of doing so and not having a “commitment to a series of hikes is specious.” In his opinion the Fed sits in a role of guiding the more cyclical economic growth trajectory of the United States, versus acting in a reactionary fashion and adjusting rates as they see fit. Summers is also right to point out rate hikes shouldn’t come until there is a commitment of continued hikes.
The takeaway from all of this is really the bind US policy makers, and the global economy finds itself. Just this week Citibank’s Global Chief Economist stated there is a 55 per cent chance the global economy will slip into recession. And although the contraction and time horizon both are forecast to be moderate, it speaks to a level of uncertainty and fragility the financial markets are effectively displaying. At the same time, we have a US economy projected to grow between 2.5 and 3 per cent in 2015 with an employment rate moving near and soon below 5 per cent, which indicates a rate hike from the Fed.
As it is clear Wall Street is no longer predominantly bullish on US stocks, the question is whether the outlook for US growth can look past the uncertainty elsewhere in the world. As notable economists like Larry Summers, and many others have pointed out, a ‘one and done’ is not what the Fed intends to achieve when they raise rates. Should they decide to hike this Wednesday, it would likely imply a level of confidence in the US to navigate the perils of a China and emerging market slow down. From similar logic, if a threat of a global slowdown will substantially affect US growth, the beginning of higher interest rates may be delayed a little longer. Will they or wont they carries deeper implications than the simplicity of “global uncertainty,” and investors have to be cautious to the consequences.