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Economic Evidence Will Force Fed to Hike Rates

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Wednesday, 19 December 2018 09:40 AM Current | Bio | Archive

Will the Fed Raise Rates Today?

Many ask themselves: “Why should the Federal Reserve raise rates today?”

Well, there are at least a couple of reasons for doing that.

The first is the economy. By raising rates, the Fed will not be trying to lower inflation. Instead, the Fed will be trying to keep inflation stable around current levels.

Fed policy changes today will affect the economy out to 2020.

So, if the Federal Reserve wants inflation around 2 percent in 2020, the policy decisions to achieve that need to be taken today.

The U.S. economy is slowing down and it should be slowing down from the temporary sugar high of the tax cuts earlier this year. Moreover, if an economy is slowing from above trend to trend growth, and with inflation that is normal, a labor market that is tight, and wage pressures that are rising, running interest rates that are at zero or negative in “real” terms, depending on whether you are a saver or a borrower, it would be “loco” not to raise rates today, to use a technical term.

To this, there can be added a second and more controversial reason to raise rates.

One of the successes of modern economics in recent years has been the achievement of broadly low and stable inflation in most major economies.

No one expects U.S. inflation to return to the double digit growth rates of President Richard Nixon’s time.

A major reason for this success has been establishing politically independent economists that run central banks as the norm in most of the major economies around the world. 

The challenge to central bank independence is highly dangerous. No one in the financial market would welcome a return to the days when Fed Chair Arhtur Burns would ask President Nixon what to do with interest rates. 

If the Fed failed to raise rates today, that might seem like a reaction to political interference. If that view were to take hold in the financial markets, there would be very likely a negative reaction.

Now, should the Fed care about recent equity market weakness? The Fed did not, after all, accelerate its tightening of policy when the equity market rallied earlier in the year. That was because the rally was in part due to corporate tax cuts, which transfer wealth from the government to “listed” companies.

The recent selloff is in part or whole about tariff (tax) increases. Trade tariffs (taxes) transfer wealth from U.S. companies and U.S. consumers to the government.

If the Fed believes that the equity market moves reflect this wealth transfer, there is no need to react.

Only if the Fed believes that the equity market is signaling future economic activity for the economy as a “whole”, then the Fed should pay attention.   

Besides that, the language around future trade tariffs has become somewhat more positive.

U.S. Treasury Secretary Steven Mnuchin indicated that there would be talks with China in January over the issue of trade. Mnuchin said the two sides had held several phone conversations in recent weeks, and were planning further formal talks, Reuters reported.

Trump administration officials had not disclosed plans for face-to-face meetings since the December 1 trade truce reached between President Trump and the Chinese President Xi Jinping that led to a delay in planned U.S. tariff increase until March 2.

Italy’s Budget Deficit

It now appears that the Italians are having a “Macron” moment. A Macron moment occurs when governments breach the European fiscal rules without repercussions.

Media reports suggest that an informal deal has been done with the EU over the Italian budget deficit. There are no details but presumably this will avoid penalties for breaking the EU fiscal rules, perhaps by “pretending” that the EU fiscal rules will not be broken.

No doubt, it will all be calculated with “absurd” precision to 2 decimal places, but it generally underscores that while Italy may be a problem economically, it’s unlikely to be a crisis, which is of course very important for investors.

Brexit Saga Continuous

Meanwhile there has been another vote of no confidence proposed in the UK government. It’s not from the official opposition, which seems opposed to opposing the government.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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If the Fed failed to raise rates today that might seem like a reaction to political interference. If that view were to take hold in the financial markets, there would be very likely a negative reaction.
fed, hike, rates, economy
Wednesday, 19 December 2018 09:40 AM
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