Is the only reason for the Federal Reserve to raise its policy interest rate right now is to save face?

Over the past year or so, the Fed has maneuvered itself into its present predicament. Its efforts at "forward guidance" and its use of models that may not be completely appropriate in this economic environment have boxed the Fed into a corner -- if the Fed were fighting itself.

The world has not turned out the way Fed officials thought it would: No one saw economic growth remaining as mediocre as it has been; no one saw Chinese growth slowing down the way it has, coupled with a move to focus its economy more on consumption and less on investment; no one foresaw the European Union stalling the way it has; no one could imagine oil prices falling from around $110 a barrel to close to $35 a barrel; no one could have projected the fall in commodity prices to the levels they are now at.

No one saw the emerging market nations of South America facing its current problems; Venezuela is near collapse; Argentina is on the ropes with a new government; Brazil is in a real mess with its president facing impeachment charges.

And, there is the situation in the Middle East and the possible world-wide terror threat arising out of this muddle.

What about Russia and the Ukrainian situation and the Turkey challenge and the economic depression that it finds itself in? And that's not even mentioning the tricky economic conditions here in the U.S.

But financial markets are forecasting, overwhelmingly, that the Fed will raise its policy rate this week. Investors have placed the probability of this happening, at last glance, more than 85%.

And, officials at the Federal Reserve have seen their credibility challenged more this fall than ever. They almost have to raise the rate this week, even just to assert themselves.

But, what happens after that?

Some analysts see that the Fed will have to reverse itself in the next year as world economic conditions are such that the higher rate will have to be moved back down.

A rising rate, these analysts say, will cause the value of the U.S. dollar to rise, especially against the Chinese currency, the renminbi. This will further hurt the Chinese economy and China will, as a result, additionally cut back on its global demand for commodities.

This will be disastrous to emerging nations, which are already in trouble because it will result in even lower commodity prices, which are vital to these countries, and it will also result in further debt problems to these countries who have vastly overextended their borrowing capacity.

This will stifle global growth even more, will hurt the U.S. economy and the Fed will end up returning its rate back to the current level.

Another group of analysts believe that the "profile" of interest rate changes in the future will be relatively flat. That is, the Federal Reserve has to raise its rate this week, but given the weakness in the world economy and the slow rates of growth, there will be very little justification for many -- or any -- interest rate increases in 2016.

There are few that see the Fed's policy rate rising steadily over the next year or two to around 3% or so.

Officials at the Federal Reserve have created this dilemma themselves. It may be very difficult resolving it because they appear to have learned very little from the changing economic climate now being observed in the world.

If these officials learn anything, let us hope that they will begin to see clearly that the functioning of the Federal Reserve cannot just be focused upon what is happening within the United States.

The Federal Reserve is not the central bank of the world, yet its strength and power within the global economy is such that it cannot ignore the central position it plays. It's decisions impact almost everyone. It needs to take that into account.

The Federal Reserve will likely raise its policy rate this week by 25 basis points. However, following this, Fed officials must move to reassess the way it operates in the future.

 

 

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.