Oct 21 2016 - Raising Rates in November Is the Most Apolitical Thing the Fed Can Do
Presidential candidate Donald Trump has accused the Federal Reserve ("Fed") of being completely political with its monetary policy. A calm and very diplomatic Janet Yellen, who is chairman of the Federal Reserve, says the Fed is not political and that politics never enters the discussion at Federal Open Market Committee (FOMC) meetings.
We believe what Ms. Yellen says in that regard and we also think the most apolitical thing the FOMC could do is decide to raise the target range for the fed funds rate at (deep breath) the November 2 FOMC meeting.
An Unconventional Idea
Bear with us as we make a most unconventional argument.
We say it's unconventional because the conventional wisdom of the fed funds futures market implies there is very little chance the FOMC would do such a thing. According to the CME's FedWatch Tool, the fed funds futures market is pricing in only a 10% probability of a rate hike at the November meeting.
It's also unconventional because most market watchers think the FOMC changing interest rates right in front of a presidential election would wreak of playing politics since it might throw the capital markets into a tizzy and unduly influence voters' thinking on election day.
Call us naive, but with the two leading presidential candidates before us, we suspect most voters who are actually going to vote on November 8 already have their mind made up about who they are going to vote for and aren't basing their decision on whether the stock market freaks out a bit just before the election.
The election polls admittedly might suggest something different between now and November 8, yet we look at those polls in much the same way we look at consumer confidence readings. That is, we take them with a grain of salt knowing people often say one thing and do another.
In any event, Ms. Yellen herself has informed the market that the November meeting is a "live" meeting when it comes to the possibility of raising the fed funds rate. Other Fed officials, like Cleveland Fed President Mester, who wanted to raise rates at the last meeting, have provided a similar reminder.
This market still isn't buying it, as just about every narrative points to the idea that the FOMC will skip November and raise rates at the December 13-14 FOMC meeting, assuming there are no major economic hiccups before then.
We get why that is the case and it may ultimately prove to be right. We just want to make a case today for why the FOMC could put politics aside and raise the fed funds rate on November 2.
That case is rooted mainly in the changes that have occurred since the FOMC found it reasonable to raise the fed funds rate last December.
With that, let's talk a little about then and now.
Then and Now
Then: The PCE Price Index, which is the Fed's preferred inflation gauge, was up 0.5% year-over-year
Now: The PCE Price Index is up 1.0% year-over-year
Then: Average hourly earnings growth was up 2.4% year-over-year
Now: Average hourly earnings growth is up 2.6% year-over-year
Then: Household net worth stood at $85.1 trillion
Now: Household net worth stands at $89.1 trillion
Then: the unemployment rate was 5.0%
Now: the unemployment rate is 5.0% (and went as low as 4.7% since the last rate hike)
Then: The UK was still part of the European Union
Now: The UK is still part of the European Union, but it is on its way out following the Brexit vote
What It All Means
The charts above demonstrate that things aren't particularly any worse for the wear since the last time the FOMC increased the fed funds rate.
According to the Atlanta Fed's GDPNow model forecast, third quarter real GDP growth is expected to increase at a seasonally adjusted annual rate of 2.1%. Taking into account recent revisions, we know now that third quarter real GDP in 2015 -- the last complete GDP data point before the December 2015 rate hike -- was up 2.0% at a seasonally adjusted annual rate.
These dynamics are a big reason why the market has formed a strengthening belief in the thought that the FOMC will raise the fed funds rate again this December. The CME Fed Watch Tool shows there is a 70.2% probability of a rate hike in December versus a 63.4% probability seen before the release of the September employment report.
If what is known today is seemingly good for a December rate hike, why not just get the ball rolling in November?
The definition of 'apolitical' is not interested or involved in politics. To abstain from a rate increase in November on the tacit notion that it could unduly influence the election would be an entirely political thing to do.
That's not to suggest the Fed would be playing politics in the way Donald Trump likes to think it is, only that holding back on a rate hike out of concern it will influence the election result is at its very essence a political way of thinking.
Do economic conditions truly warrant an effective fed funds rate today of 0.375%, which is close to where it stood in November 2008 when the financial and economic world was falling apart?
Savers probably don't think so, but it is of course the great source of debate.
FOMC members will have a vote on November 2. They should cast it for a rate hike. Why? Because it would be defensible based on the data in hand and it would be the most apolitical thing the Fed could do.
It probably won't happen, though, because unconventional wisdom doesn't fly at the Federal Reserve, which is too careful these days not to upset the market's conventional wisdom.
--Patrick J. O'Hare, Briefing.com