After October's blockbuster employment report, bond markets began taking the possibility of a December rate hike by the Fed seriously. The Fed Funds Futures rate, which is used by many to predict the odds of a rate hike, is now showing a 70% chance of a December liftoff from near-zero interest rates.
But despite the Fed unifying behind December in recent statements as the most likely time for the first rate hike, there are some who say that raising rates now is a big mistake with global repercussions.
Why The Fed Should Wait on a Rate Hike
Most of the arguments against a Fed rate hike in December are related to the global economy, and the spillover effects higher interest rates in the US would have to the world at large. Here are some of the factors the Fed should consider before pulling the trigger on the first rate hike since 2006.
The Global Economy is Too Weak
The Organization for Economic Cooperation and Development (OECD) recently cut its estimate for the global economy. Emerging markets, which have been hit by a slowdown in China, are the major risks to economic growth in developed nations. A Fed rate hike would increase borrowing costs for these nations, and reduce their imports of US goods.
The CEO of the world's largest shipping firm, A.P. Moeller-Maersk, says that the economy is even worse than the official estimates say. He bases this opinion on the large amount of excess shipping capacity across the globe. Nations aren't shipping things to each other, signifying a drop in international trade.
The Strong Dollar is Hurting US Exports
Rumors of a December rate hike have already sent the US dollar to seven-month highs. Some analysts expect it to climb even higher once a Fed rate hike materializes, especially against the backdrop of other central banks pursuing even looser monetary policies. Foreign currency devaluations at the same time the Fed hikes rates gives a double boost to the strength of the dollar. The strong dollar is already causing job losses as companies with large export markets have to cut back production.
Other Central Banks Are Easing
The European Central Bank and the Bank of Japan are actively loosening monetary policy and engaging in quantitative easing. Even the Bank of England, long considered the central bank most likely raise rates before anyone else, has put off the first rate hike until 2017. BoE governor Mark Carney cited the global economic slowdown, and ultra-low inflation as the main reasons behind the decision. The European Central Bank, which meets two weeks before the Fed next month, is contemplating driving interest rates even deeper into negative territory.
The Inflation Rate is Too Damned Low
Critics of a rate hike note that inflation is still below 2%, where it has languished for the last four years. An interest rate hike will add deflationary pressures to US inflation rates. Economist Paul Krugman, a noted inflation dove, warns that raising rates now could send the weak global economy into recession. The head of the Bank of France noted that inflation was too low and economic growth too weak in the Eurozone. A rate hike by the Fed would force the ECB into more quantitative easing and other stimulus, and roil Western Europe at a time it is struggling with the sudden expense of caring for millions of refugees fleeing war and poverty.
All The Information Isn't In, Yet
Rate hike skeptics note that the blowout non-farm payrolls report was a strong incentive for the Fed to raise rates in December, but the NFP for November, which is released two weeks before the FOMC meeting in mid-December, could reverse plans to raise rates in the near future. This is in addition to the slew of economic news that will be reported in November.
Holidays Mean Low Liquidity
Mid-December is a bad time for this first rate hike, critics say, because so many traders take long Christmas holidays. With fewer people trading, volume and liquidity is low. A rate hike could ignite a great deal of volatility in a thin market.
Why The Fed Should Raise Rates in December
The reasons why the Fed should raise rates next month are perhaps more convincing than the reasons against. Here are a few of them.
The Payroll Report Was *Really* Good
The #1 reason traders are putting the odds of a December rate hike at over 70% is the non-farm payrolls report released last Friday. Not only did 271,000 jobs gained in October blow away a consensus of 185,000, the number of people working part-time against their will dropped as these people found full-time jobs. This report ticked all the checkboxes for a December rate hike.
The Feds Are On The Same Page
The Fed has likely reached a consensus on a December rate hike, with all officials keeping to the same page in public remarks. This is in marked contrast to earlier this year, where officials were contradicting each other on a daily basis. Here are some of the things that have Fed Chairman Janet Yellen calling December a "live possibility" for the first rate hike. Even the most dovish of Fed officials are admitting the possibility of a December move.
Starting Now Allows A Gradual Path
The argument of interest rate hawks is that the earlier the Fed begins to lift rates, the slower it can go to reach a "normal" level. This way, rate hikes don't introduce as much volatility into the markets with each increase. Bank of America analysts say that economic conditions at home and abroad are good enough to raise rates in December. "Bond King" Bill Gross says he's 100% sure the Fed will hike rates in December.
San Francisco Fed president John Williams said recently that "We can't wait until we see the whites of inflation's eyes"; if we did, we would overshoot the mark. An earlier start to raising rates would also allow a smoother, more gradual process of policy normalization, giving us space to fine-tune our responses to any surprise changes in economic conditions."
The Federal Reserve is facing a crisis of confidence when it comes to the markets. This growing lack of credibility has many analysts believing that Fed has to raise rates in December, even if it's just 1/8th of 1 percent. Fed head Janet Yellen told Congress that a December hike was a "live possibility," even before the monster beat in non-farm payrolls. If, after all this talk, Yellen doesn't raise interest rates next month, no one will take the Fed seriously in the future.
Place Your Bets
While a December rate hike seems like a "sure thing" right now, if the economy stumbles in the next four weeks, we may not see the Fed raise rates until next March.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.