Tags: Fed | rates | dollar | stock

Why the Fed Must Raise Rates This Year

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Thursday, 12 Feb 2015 08:12 AM Current | Bio | Archive

Last year the Federal Reserve announced its intention to begin raising discount rate, with a data-dependent target of mid 2015. Almost every single day analysts, pundits and money managers weigh in on whether the central bank should actually do it.

There are those who say it would be foolish for the Fed to raise rates any time soon.

Former General Electric CEO Jack Welch recently said it would be "ludicrous" to raise rates. Former Treasury Secretary Larry Summers said the Fed should not begin raising rates "until it sees the whites of inflation's eyes." Analysts at Morgan Stanley predicted in late January that the central bank won't hike rates until March of 2016.

The basic argument from the nah camp is that the dollar is too strong already, there is a bigger threat of deflation than inflation in this slow global economy and rates across the globe are at rock bottom levels. Raising rates would further strengthen the dollar and possibly jolt the already fragile global economy. There's no good reason to do it.

However, the consensus opinion seems to be that the Fed should raise rates. The argument there is essentially that interest rates are still priced for Armageddon and the U.S. economy is too strong to still have rates at that level. Employment numbers, consumer confidence, housing starts and leading indicators in general are the best since before the recession. If you can't raise rates beyond near-zero levels now, when can we?

I am with the camp that says rates should be raised. I believe that the Fed raise rates by June for three primary reasons.

1. They said they would.

Sure, the Fed has given themselves some leeway with phrases such as "data dependent" and "patient." But, make no mistake about it. They have indicated to the world that the Fed will start raising rates in 2015. Partly as a result of that indication, markets and asset prices across the globe have re-priced.

The dollar has soared and commodity prices have crashed partly on the understanding that U.S. central bank policy would move toward tightening this year. They can't just turn around and not do it.

Credibility is the Fed's stock and trade. If financial people throughout the world find that they made a terrible mistake because they took the Fed at its word, they will cease to take the Fed at its word. Such an occurrence would greatly impair the Fed's ability to affect things going forward.

2. They can't fall behind.

The Fed is supposed to be a stabilizing force. Ideally, it sets longer-term policy goals and isn't overly influenced by the latest headlines. Right now, the global economy is sputtering, commodity prices are near the lowest since the financial crisis and the dollar is king. But all these phenomena can be quite temporary. Things can change fast. In just a few months the world can look a whole lot different.

The last thing the Fed wants to do is fall behind and get in a position where it has to raise rates fast to make up for lost time and spook the markets.

3. The need to reload.

As longer-term thinkers, the Fed needs to start to prepare for the next phases of the economic cycle. Recessions come along every eight years on average, and the last one ended almost six years ago. When the next recession comes, the Fed will need the ability to ease by lowering interest rates.

That important tool will not be available unless interest rates are substantially higher than the current near-zero levels. It's high time to begin raising rates, especially since the Fed likes to increase rates very gradually.

It's worth noting that the Fed will not have to raise rate by much. The central bank can choose to raise rates just 0.50 percent or even 0.25 percent. Such an adjustment would make little difference. Loans will still be dirt-cheap and there will still be little alternative to stocks.

But there must be a rate hike in June or September at the latest. The Fed has already committed. I believe the Fed will start raising the discount rate in June. It has to happen. Expect it.

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TomHutchinson
Last year the Federal Reserve announced its intention to begin raising discount rate, with a data-dependent target of mid 2015. Almost every single day analysts, pundits and money managers weigh in on whether the central bank should actually do it.
Fed, rates, dollar, stock
698
2015-12-12
Thursday, 12 Feb 2015 08:12 AM
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