When the Federal Reserve ticked the interest rate up to 0.25 for the first time in a decade last December, it was something of big moment — it was the first time the rate has been above zero in almost a decade.
In the wake of the financial crisis, the Fed officially cut the interest rate in the U.S. to zero, and there it remained for seven years.
The plan — or, at least, the widely expected course of events — was that the U.S. economy, with the recovery underway, would see the Fed incrementally tick up interest rates throughout 2016, with an overall goal of ~2 percent, coming close to 2008 levels.
Unfortunately, for those looking for the long freeze on interest rates to give way to a thaw, the economy did not quite cooperate in 2016.
The 2015 holiday sales season was weaker than expected across retail, followed by a plunging and then bumpy stock market in late winter and early spring spurred by uncertainty about the Chinese economy. As summer was heating up, so were talks of an incremental rate raise, and so too were the emotions of the folks in the U.K. One Brexit later, international markets were thrown into turmoil.
It seems, at every turn in 2016, when the rates might have had a chance of going up, something intervened.
Which leads to next week’s meeting and the potential of a late September raise. A potential that seems ever narrower, given the date on the calendar and recent remarks of some senior Federal Reserve officials. The building consensus is that it probably isn’t happening this time around.
But the run-up to the meeting has been interesting nonetheless, as the calls for another raise are growing increasingly pointed. Some are from expected outsiders. Jamie Dimon has vociferously been advocating for an increase, as one might expect. But the voices are also coming from within the Federal Reserve’s governing board and publicly enough to have an effect on the markets.
With the pressure seemingly rising and the voting members getting more divided, the odds of an increase coming sooner rather than later look high.
Why It’s Not Happening In September
Apart from the various strains of tea leaf reading going on trying to parse the various public statements of multiple Fed officials, there is the indisputable reality of the calendar.
The Federal Reserve board meets on Sept. 20 and 21, and the presidential election is on Nov. 8. Most experts agree the Fed is usually hesitant to be accused of acting in a way that “places the thumb” on the scale of an election one way or the other and, as such, is unlikely to make a move to raise interest rates six weeks before the vote.
Moreover, as the period before the blackout before the meeting is drawing to a close, the last public comments from a Fed official on the subject seemed to strongly indicate that the Fed was leaning toward holding the rate in place.
Lael Brainard, a Federal Reserve governor, said on Monday (Sept. 12) that she still favored “prudence” in raising interest rates, reinforcing the increasingly widely held opinion that the Fed will not raise the rate. Brainard is a longtime advocate of continuing stimulus policies, despite signs of economic recovery.
In her speech to the Chicago Council on Global Affairs, she said that inflation remains weak and that the labor market continues to heal.
“In the presence of uncertainty and the absence of accelerating inflationary pressures, it would be unwise for policy to foreclose on the possibility of making further gains in the labor market,” she said.
She further noted that the weakness of the global economy remains a headwind against the U.S. economy, and the risks in the Fed waiting too long to raise rates were much lower than the risks of ramping them up too quickly.
She noted the Fed has limited tools to ward off economic weakness, but it has a lot of power to prevent excessive inflation.
“I believe this approach has served us well in recent months, helping to support continued gains in employment and progress on inflation.”
Chances of a rate hike at the Fed’s next meeting immediately dropped as news of Brainard’s speech broke. Traders now anticipate just a 15 percent probability, down from 21 percent before the speech and as high as 30 percent on Friday.
The likelihood of a move before the end of the year perked up a bit slightly, now standing at 59.2 percent, up from 57.7 percent.
The Increasingly Loud Calls For A Raise
The meeting next week will take place with an increasingly divided policymaking committee. President of the Federal Reserve Bank of Atlanta Dennis Lockhart spoke a few hours before Brainard and noted that the time has come for the Fed’s “serious discussion” about raising rates.
He did say, though, it was not urgent for the Fed to act in September.
Last week, Federal Reserve Bank of Boston President Eric Rosengren managed to trigger a stock selloff with his public call to raise interest rates. And it wasn’t a small drop; the Dow closed down nearly 400 points. That represents most of the post-Brexit trading gains made over the course of the summer.
Rosengren used to be a fan of the zero interest rate policy as a method of stimulus but is now publicly concerned that the practice has overstayed its welcome, running the risk of creating bubbles, particularly in the commercial real estate market.
Rosengren is a voting member of the Federal Open Market Committee, the central bank group that sets rates to guide the decisions.
“A failure to continue on the path of gradual removal of accommodation could shorten, rather than lengthen, the duration of this recovery,” Rosengren told the South Shore (Boston) Chamber of Commerce.
Rosengren did not say whether he would prefer to increase a key benchmark rate from 0.25 percent to 0.5 percent later this month or at one of the Fed’s scheduled meetings in November or December. Investors clearly bet on sooner rather than later, triggering the selloff.
Now What?
Going into next week, Fed Chair Janet Yellen faces an increasingly sharply divided committee and the pressure of no rate raise so far in 2016, despite early-year projections for there being four of them.
Yellen said in an August speech that the case for a rate increase had become stronger in recent months. However, she didn’t say that the time is now to raise rates. Plus, given the shape of the calendar for 2016, it seems unlikely the Fed will vote to raise them on Nov. 1 when it next meets — a week before the election.
But pressure continues to build for a rate increase before the end of the year.
Jamie Dimon, speaking yesterday at the Economic Club of Washington, noted the situation was getting untenable.
“Let’s just raise rates. The Fed has to maintain credibility. I think it’s time to raise rates. Normality is a good thing, not a bad thing. The return to normal is a good thing.”
And an especially good thing for banks, like the very big one Dimon heads up, as the incredibly low rates have both taken a bite out of their bottom line and made the conditions especially favorable for the alternative lending startups that have risen to disrupt them. Higher interest rates make consumer and SMB lending more tempting for FIs and make conditions harder for alt-lenders who have to adjust their rates up accordingly.
And it seems the increase is coming — maybe not next week and probably not in November. But it looks like banks might get another interest rate raise before the year is out and, at the rate things are going, just in time for Christmas.
Ho, ho, ho.