J. Powell, the Fed’s Chairman, faces a problem; perhaps
the biggest challenge in his tenor so far. The financial markets – mainly equities
in the U.S. – have signaled that they cannot
and won’t stand another rate hike. Over the past three months, the plunge in equities’ prices has led market participants
to speculate that there will be no further rates hikes in 2019 as the Fed has already raised four times in
2018 to 2.5%. Currently, according to the CME,
the financial markets price no hikes in 2019 (less than 12% as the table below
shows by the end of the year).
On the other hand, the U.S. president has been bashing
the Fed chair for raising rates too much and too fast. Also, now there are talks of a possible meeting to be held between the
two – something that could put further into question the independence of the
Fed. After all, if the Fed does listen to the markets and not raise rates, we
will not know for sure if this is because the Powell
the rest of the FOMC members think it’s
the right thing to do for the U.S. economy or whether he’s given in to pressure from the president.
Don’t get me wrong, I also think the Fed shouldn’t raise rates any further in the coming months. And perhaps that’s
what the Fed will eventually do. However,
this is not how such a decision should be made.
Not in such an environment where the Fed’s independence is being questioned.
The Fed has penciled in 2 more hikes in 2019, although
Powell kept assuring in the last press conference, following the December FOMC
“there’s significant uncertainty about the—both the path and the ultimate
destination of any further rate increases”.
This means that if economic data were to show some further slowdown in the
economy, that could push the Fed to pause and not raise rates anytime soon and
perhaps even not at all in 2019. But the
markets are already putting down the Fed for now hikes this year – which could
partly explain the end of the year bounce back in equities (another couple of
issues that might explain the recent rally include the favorable technical
signals for algo-trading and the hopes of
trade agreement between the U.S. and China – although at this point I don’t
know how many more times the markets are willing to play Charlie Brown and let Lucy
(the U.S. president) pull the ball off right before kicking it again).
So, if the Fed doesn’t
raise rates again, it may not be enough to calm markets and they are likely to seek further hints of rate cuts, which are
starting to appear in the markets, as you
can see in above table. And if the Fed does go along and raise rates
again even one more time – a very plausible scenario – the markets are likely to
resume their downfall and put more pressure on the Fed. Now, letting the
markets lead the Fed is something that we have seen in 2015 and 2016. As the Fed was expecting to raise rates
several times each year and only wind up raising once each year. Each time, Chair
Yellen was willing to listen to the markets and adjust the path of the rate
hikes. Back then, however, unemployment was higher, wage growth much lower and there
was no fiscal stimulus nor a massive buildup in U.S. debt. So, there is a case
to be made, albeit not a great one, for higher interest rates.
What should be the Fed Chair’s next move?
Perhaps Powell, in his upcoming talk on Jan. 4th,
could use forward guidance and assure markets that rate hikes are possible (albeit
not certain, without making commitments, data
dependent yada yada) in 2019. Forward guidance could start pushing back up the
chances markets currently give of a rate hike. This move could also indicate the Fed of how severely markets were
to react to a mere possibility of another rate hike.
But if Powell doesn’t succeed in
lifting market expectations for more possible hikes in 2019 all awhile reaffirming
the Fed’s independence from the White House, he might just lose some of the Fed’s integrity when the markets need it the most – in the next economic downturn.