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  Rate Hike Looks Set for December
Posted Under: Government • Research Reports • Fed Reserve • Interest Rates

 

The Federal Reserve kicked the rate hike can down the road once again, but looks very likely to raise rates in December. 

The biggest news today wasn't the Fed's unwillingness to raise rates; if the Fed has been seriously considering a rate hike they would have made that clear to investors in the past few weeks.  Instead, today's biggest news was that three members dissented from the (lack of) policy action, all preferring a quarter-percentage point rate hike at today's meeting. 

How can we be confident about a December rate hike given how often the Fed has punted on rate hikes so far this year?  Because the new dot plot released today from the Fed shows that, with only two meetings left this year, fourteen of seventeen policymakers think rates will rise by at least 25 basis points by the end of 2016, with only three thinking rates will finish 2016 without any rate hike at all.  In addition, Fed Chief Yellen said at her post-meeting press conference that "most" policymakers (you can bet this group included her!) already think the time is appropriate for a rate hike, but that it wouldn't hurt to wait a little while before doing so.

Another way to think of it is that the three who dissented today will likely dissent in November as well, and then the Fed will swap dissenters in December, with the three who want to wait until at least next year for any rate hikes, finally finding themselves on the losing end of the policy decision.

So if the Fed is ready to raise rates, why not do it at the next meeting in November?  Because it's only six days before the election and we think the Fed would prefer to stay out of the limelight so close to Election Day.  

Other notable shifts by the Fed in its policy statement include:
(1) Recognizing a pick up in the growth of the economy,
(2) Saying the near-term risks to the outlook are "roughly balanced," rather than a "diminished" risk of downside developments, and
(3) Adding that the case for rate hikes has strengthened.

The Fed also made slight downward revisions to its projection for real GDP growth, both this year and for the long-term average.  As a result, the projection for the long-term average annual growth rate for nominal GDP (real GDP growth plus inflation) is now 3.8%. 

In terms of the pace of rate hikes, the median projection from policymakers is only two rate hikes in 2017.  With the long-term average remaining at 3.00%, that means more rate hikes in 2019-20, instead. 

In our view, economic fundamentals warranted a rate hike at the start of the year, and even more so today.  The economy can handle higher short-term rates. The unemployment rate is already very close to the Fed's long-term projection of 4.8% and nominal GDP – real GDP growth plus inflation – has grown at a 3.3% annual rate in the past two years.  Moreover, we are starting to see early signs of accelerating inflation.  "Core" consumer prices are up 2.3% versus a year ago, tied with the largest increase since 2008.  Average hourly earnings are up 2.4% from a year ago, despite many highly paid and productive Baby Boomers exiting the workforce.
 
Slightly higher short-term rates are not going to derail US growth, but will help avoid the misallocation of capital that's inevitable if short-term rates remain artificially low.   

Brian S. Wesbury, Chief Economist
Robert Stein, Dep. Chief Economist

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Posted on Wednesday, September 21, 2016 @ 3:48 PM • Post Link Share: 
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