
2 Big Reasons The Fed Won't Raise Rates This Year
Wall Street is back on FedWatch this week, waiting for the announcement Wednesday on whether the Federal Reserve will raise interest rates for the first time since 2006.
And the odds are that the hike won't come this week, or December--but will instead wait until next year.
Certainly, that's how markets see it. According to CME FedWatch, futures prices suggest the central bank is only 39% likely to boost rates by December's meeting, and that there's little chance it will this week.
The twist at this meeting is that two members of the Fed's Open Market Committee, Dan Tarullo and Lael Brainard, have publicly suggested that the Fed should wait longer, contradicting the Fed's Big Three of Chair Janet Yellen, Vice Chair Stanley Fischer, and New York Federal Reserve Bank President Bill Dudley, who have said that the first hike will likely happen in 2015.
The interesting part of Tarullo's--and especially Brainard's--dissent is that they flesh out the case for waiting longer, and add nuance. By making the argument stronger, they make the outcome more likely. Some highlights:
It's Not Just China.
China's slowdown doesn't just hurt U.S. exports to the Middle Kingdom, Brainard argued in an Oct. 12 speech to the National Association of Business Economists. She argues that nitwits like this guy who focus on the fact that exports to China by companies like Apple (AAPL) - Get Report Caterpillar (CAT) - Get Report and General Electric (GE) - Get Report are only 0.7% of U.S. output don't account for exports to all the other countries whose economies get a crucial boost from shipping raw materials (mostly) to China.
Brainard notes that Canada is having a renewed recession, thanks in part to slowing exports to Asia. (Canada also is more energy-industry dependent than the U.S., getting 20% of its economy from natural resources businesses). It's an elegant, if incomplete, answer to the theory that a renewed recession, or at least a major slowdown, can't happen here.
'Waiting to See the Whites of Inflation's Eyes'
The two doves also added wrinkles to the debate over inflation that will be new to some observers, though pretty intuitive to those who have been following closely.
One is that inflation looks really, really dead for longer than you think. Brainard pointed out that not only has inflation not budged, but that expectations of future inflation have stayed stock-still since 2012.
The other is Brainard's less-familiar argument that the balance of risks calls for taking a chance on inflation rather than the (small) risk of a recession here. The Fed's tools for bringing down inflation are well-understood, since central banks have used them many times before. No one really knows how effectively central banks can use negative interest rates and other methods to revive an economy that lapses back into recession with rates still near zero, she said.
That's actually pretty smart--especially since there hasn't been a year when core inflation topped 2.25% since 1993. Inflation is both unlikely to flare up and easy to tamp down. That means it's smart to take the chance of having to fight inflation later in order to offset the risk of a Canada-like, or Europe-like slowdown soon.
Paul Krugman has called this argument waiting to see the whites of inflation's eyes before taking the chance of smothering the recovery. Certainly the 2.08% interest rate on 10-year Treasuries say Wall Street is far from convinced inflation is coming.
At the same time, the economy has shown signs it's getting firmer footing recently. As poor as forecasts for third-quarter growth are- the first official estimate of gross domestic product will be released Thursday - it's also becoming clear that the main thing slowing down is the pace of inventory stocking.
GDP grew only at a 1.5% annual rate, Barclays economist Michael Gapen wrote last week - but domestic final demand is a very-healthy 3.6%, led by auto sales at General Motors (GM) - Get Report and Ford. (F) - Get Report The issues are 1.4 percentage-point cut in growth just from the very-volatile inventory numbers and another ding from trade. Domestic demand is growing about as fast as in the second quarter, for all the sturm und drang about China, validating the market's rise since August. That reflects not only consumer-spending growth that continues well above 3%, but also decent investment numbers, led (surprise!) by housing.
Gapen says this could embolden the Fed to raise rates by December. And that view did begin to show up in futures prices on Friday. Even Tarullo, before he began talking about rates specifically, told CNBC's Steve Liesman that loan demand is doing well at banks, which helps the Bank of Americas (BAC) - Get Report and Wells Fargos (WFC) - Get Report of the world.
It's also worth noting that the economy is moving steadily toward Yellen's benchmarks for measuring how the recovery is helping working families. Beyond the 5.1% unemployment rate, the sum of unemployment and underemployment that the Labor Department calls the U-6 rate has reached 10% and is falling rapidly. Median household income is now within 1.7% of its level in the uber-good times of January 2000, and at a post-recession high. It's not a tough argument to make that Yellen's call for patience until the benefits of growth reach everyone is almost fulfilled.
What tips the argument is that super-low inflation means the Fed can leave rates near zero for a spell longer than nearly-recovered wage and employment stats absolutely require. Think of it as buying insurance, and the expiration date on this policy looks like March 2016.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.








