Unless you’ve actively tried to avoid the conversation, if you work in the financial world, the topic of the Fed raising rates in September is unavoidable. Everyone has an opinion, which range from relief that the Fed is actually doing something besides providing the spike to the party’s punch, to disgust that the Fed would consider a rate hike when most other countries’ central banks are becoming looser with their monetary policy.
A Look at the Fed’s Central Tenant
The Fed’s charge, often referred to as its dual mandate, is maximum employment and stable prices. This vague mandate leaves considerable judgement to officials running the Federal Reserve, mainly the chairperson and members of the Open Market Committee.
Inflation
Here’s a look at one side of the dual mandate. It is the year-over-year growth in prices, often called inflation. Interestingly, it is fairly likely that prices may decline into negative territory in the coming months, meaning that, if the Fed raises rates in September, it may be raising rates during a period of brief deflation.
Professionals don’t usually assume that central bankers raise interest rates to eliminate deflation. In general, it’s the other way around.
Employment
Here’s a look at the other component of the Fed’s dual mandate – employment. The graphic shows year-over-year growth in U.S. Employment at 2.09%, a healthy growth figure by recent experience.
What is interesting is that employment seems to have peaked. If you look closely, employment growth peaked in February 2015 at 2.34%. Employment growth is now on a decelerating trajectory. Other measures, including Average Hourly Earnings, the Unemployment Rate, the Labor Force Participation Rate, and others suggest the American labor market is on moderately good ground, but no where near bubble territory.
What Are the Reasons?
With the observation that inflation fails to provide a reason for the Fed to tighten rates, and the labor market looking like it is peaking, what are the reasons the Fed would raise rates in September? Why are they seemingly in a hurry?
Three reasons come to mind, and none of them have to do with inflation or employment.
First, Fed officials appear to be concerned about financial assets. In particular, they continue to indicate that they think financial assets are overpriced. One of the easiest ways to dampen financial asset price growth is to raise interest rates.
Second, Fed officials may be concerned about a recession on the horizon. With international conditions on shaky ground, the Fed appears to be thinking that if they don’t raise rates now, they may not get a chance before the next recession rolls around. And, the Fed can’t allow itself to be that passive; not raising rates between two recessions is about as weak of a central bank as it gets.
Third, politics. Most everyone knows the Fed has a bias for Democratic presidents. The Fed has yet to raise interest rates during President Obama’s tenure, an incredible length of time. They are concerned that if they don’t do it soon, the Fed may loose a chance. How would that look for the Fed to never raise rates during a Democratic president’s administration, the administration that nominated the sitting chairwoman?
Conclusion
In a little over a week, members of the Federal Reserve’s Open Market Committee will vote on whether to raise interest rates. With inflation possibly becoming deflation in September, and the American labor market in lukewarm conditions, one can reasonably ask why the Fed would want to raise interest rates.
The three potential triggers, interestingly, have little to do with the Fed’s two founding tenants – full-employment and minimizing inflation.
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