Investors need to consider the political dimensions of possible interest rate hikes by the Federal Reserve with the approach of the 2016 elections, said Barry Bannister, chief investment strategist at Stifel Nicolaus & Co.
The central bank is walking a fine line between critics who may say the Fed isn’t raising rates fast enough and those who will argue that hikes were too steep and triggered a recession, he said.
“We expect the Fed to ‘get off zero’ with a 25-basis-point rate increase in third-quarter 2015 simply to defuse political criticism and avoid becoming a Progressive or Tea Party populist piñata in the 2016 election,” Bannister said in a May 29 report
obtained by Newsmax Finance.
Presidential candidate Rand Paul, a Republican senator from Kentucky, has pushed for measures to audit the Fed, while Elizabeth Warren, a Democratic senator from Massachusetts, has criticized the central bank for lax oversight of the financial services industry.
In the Fed-as-piñata scenario, populists will argue the central bank needs greater supervision because its policies help to enrich Wall Street bankers while punishing workers and retirees, Bannister said. But the Fed must also do what it can to help the U.S. economy avoid a recession before Americans go to the polls in November 2016, he said.
“Given the nascent threat to its independence, we doubt the Fed wishes to cause (be blamed for) a recession in an election year,” according to Stifel's report. A recession may occur in 2017 if the Fed funds rate reaches 3 percent while inflation is near 1.5 percent, as measured by the personal consumption expenditures
price index, Bannister said.
“That puts the next recession in the first year of the first term of the next U.S. President,” he said, “quite possible in light of historical precedent.”
The Fed already may have raised interest rates by 400 basis points with the gradual end of quantitative easing, the central bank’s bond-buying programs that were intended to keep a lid on the cost of money. One hundred basis points equal one percentage point.
“A 2012 Fed study
describes their view that QE1 may have created a negative Fed funds rate of about 400 basis points in 2009,” Bannister said. “But growth, time passing, a loss of QE novelty and tapering subsequently raised rates to zero percent, which we interpret as a de facto 400-basis-point hike.”
The biggest concern with such an implied increase in rates is that it may trigger another economic meltdown, Bannister said. For that reason, the Fed is likely to raise rates as gradually as possible.
“Past 400-basis-point rate cycles (1980s, 1990s, 2000s) led to significant financial crises for which we doubt there is much Fed appetite in the 2010s,” he said.
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