Ding, dong, the rate hike is dead. (Or at least is should be.)
What should have been obvious since the beginning of this year to anyone who wasn’t trying to burnish their “hawk” credentials became undeniable this morning. Inflation is non-existent, jobs are faltering, and the economy is most definitely not overheating, even if you think the stock market is.
Durable Goods Orders Crater
Earlier this year, the Fed was looking at three, or maybe even four interest rate hikes. They pulled the trigger twice in 2017, with a rate increase in March, and another in June. Ever since then, however, the economic numbers just don’t support another hike. They never really did, but Fed officials glossed over that problem by saying the numbers were temporary.
With every new economic number to come out, however, it looks like those numbers were not only not temporary, they were part of a growing trend of an economy that is already slowing down, and maybe getting ready to reverse. Instead, it’s the “good” numbers that look like they were temporary.
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After a big increase in June, orders for durable U.S. goods fell 6.8% for July, suggesting June’s big number was the temporary number. Combine that with the fact that inflation nowhere near the Fed’s 2% target, and you have to keep asking yourself, what is the point of more rate hikes to stop non-existent inflation, and an economy that is most definitely not overheating?
Why Raise Rates in 2017 Still?
The answer is two-fold.
The unfortunate part of the answer is that there is something of an unwritten competition between certain kinds of economist as to who can be the bold on interest rates. They love being called inflation hawks, because that seems like the more responsible position. It’s kind of like the stern parent telling you to take your medicine because it is good for you. But, just like taking antibiotics when you aren’t sick is neither strong, nor prudent, raising interest rates in an economy that doesn’t support such increases is foolish.
The second reason for raising interest rates is to reload, so to speak.
The Fed’s primary tool for boosting a sagging economy is to cut interest rates, but you can’t get blood from a turnip.
With interest rate so low already, there simply isn’t room for much cutting. Sure, the Fed can snip back another 0.25% a few times, but that won’t do much in the face of an economy that slumps in what is still already a historically low inflation environment. And, with the Fed’s balance sheet already astronomically large, there aren’t a lot of non-interest rate tools left either. This is at least a sensical argument.
Damned If You Do…
So, here’s the dilemma. Raising rates may trigger the very recession that would necessitate cutting rates in the first place. In this case, not raising rates is the much smarter move. However, the expansion we are currently in has been a long, if tepid, one. The cyclic nature of the economy suggests that a contraction is coming sooner or later regardless of what happens in interest rates. In this case, reloading the Fed’s weapons makes sense.
For my part, I follow the maxim, “Don’t borrow trouble.”
There is no economic overheating, and no inflation, so don’t go worrying about what you will or won’t do when and if trouble comes. Instead, manage the economy for as much solid growth as possible and let the universe sort out when the contraction comes. A few more years of reasonable accommodation might just give this expansion another three or four years. In that time table, plenty of well-timed rate increases will reload the Fed’s arsenal, without prematurely puncturing the wheels of expansion.