“What mighty Contests rise from trivial Things … ”
Alexander Pope, The Rape of the Lock
Let’s put this in perspective. If the Federal Reserve Board raises interest rates at its meeting this week, it will likely raise them by 0.25%.
That’s 25 basis points … a quarter of a percentage point … a hair’s breadth. In the 1980s, U.S. long-term interest rates approached 20%, which is 80 times higher than the post-increase Fed rate would be.
So what’s the big deal?
The big deal is that any rate increase, even one as slight as a quarter of a point, would signal a change in direction for the Fed. It would mean that the easy money days are over. The stock market would no longer be artificially inflated by Fed policy. Yields would rise. The Keynesian bubble would burst.
Eyes on the Fed
So all eyes are on the Fed as it meets this Wednesday and Thursday. Will the Fed announce a rate increase? If so, by how much? If not, why not?
If you’re a betting person, you may want to put a wager on the outcome. If you don’t have a bookie, you can always invest in Fed fund futures.
Should the Fed raise rates, the probability is high that the increase will be just 0.25%. CME Group’s FedWatch Tool puts the odds of a 0.25% at 76.43%, while the odds of a 0.5% rate hike are 23.57%.
But that’s assuming the Fed votes to raise rates … and it’s not a given that it will. We checked Las Vegas to see what the odds of a rate increase are and found this quote on Las Vegas Now from Paul Ashworth, chief U.S. economist at Capital Economics: “The odds that the Fed will raise interest rates this month are still close to 50-50.”
Personally, we think they are a lot less than 50-50.
Under the headline, “Fed Wavers on September Rate Rise,” The Wall Street Journal reported this week that there is much division within the board about whether rates should rise.
While U.S. employment figures are showing some improvement, the Fed’s other goal of achieving 2% inflation has not been met. Meanwhile, with other countries ramping up their easy money efforts and weakening their currencies, the strong dollar would become stronger still, making American companies less competitive abroad.
Given all of the above, always outspoken Fed Vice Chairman Stanley Fischer said last month that a September rate increase has become less likely. But he’s also quoted in The Journal as saying, “I will not, and indeed cannot, tell you what decision the Fed will reach by Sept. 17.”
Then there’s this comment by former Treasury Secretary Larry Summers, as reported on David Stockman’s Contra Corner blog: “I believe the case against a rate increase has become somewhat more compelling even than it looked two weeks ago…..First, markets have already done the work of tightening. The U.S. stock market is worth $700 billion less than it was 2 weeks ago and credit spreads have widened noticeably. Financial conditions as measured by Goldman Sachs or the Chicago Fed index have tightened in the last 2 weeks by the impact equivalent of more than a 25 BP tightening. So even if resisting inflation required a 25 BP tightening as of two weeks ago, this is no longer the case.”
In other words, the stock market plummeted based on the expectation that interest rates will increase, so, as a result, the Fed doesn’t have to raise interest rates.
Stockman explains that Summers’ logic (forgive the oxymoron) is based on the Goldman Sachs Financial Conditions Index, which we would explain if we could understand it. Instead, we’ll use this summary from Stockman: “In a word, the Goldman gamblers have constructed a junk economics index that tells the Fed not to tighten because the arrival of a modicum of sanity in the casino is evidence that it has already tightened.”
Whatever happens, the Fed will likely have to come up with a new policy statement. The real fun will be taking place behind closed doors and you can bet that it will not be reflected in whatever policy statement is issued. The odds of that are 100%.