Published on Dec 20, 2017

The Federal Reserve raised short-term interest rates by a quarter point last week as the U.S. economy continues to be on get healthier. The rate hike, which was widely expected, was the third this year as Policy makers pointed to the lower number of unemployed workers, increased spending by households, and bigger investments by businesses in recent quarters. This is the fifth time the Fed has lifted interest rates since the 2008 financial crisis and will now hover in a range of 1.25% to 1.5%. Overall, rates are still historically low.

The Fed put interest rates at 0% in December 2008 to boost the collapsed housing market and bruised economy. But with the U.S. economy much improved now, it needs less of the Fed’s monetary medicine. The Fed said it continues to expect inflation to remain below its 2% target, at 1.7%, and the unemployment rate to be 4.1%, based on its updated economic projections.

However, Fed officials have been at a loss to explain why inflation, which reflects the prices of everything from meat and cheese to houses and cars, has fallen short of the Fed’s goal of 2%, which the Fed considers healthy for the economy. In deciding to slowly raise rates over the past year or so, the Fed has weighed competing forces. Stubbornly low inflation and consumer prices suggested the Fed should hold off on raising rates. But steady economic growth and low unemployment suggested it should act!

However, two Fed officials dissented on last weeks Interest Rate Hike decision:  Chicago Fed President Charles Evans and Minneapolis Fed President Neel Kashkari, who felt policy makers should wait longer before raising rates again. We concur with them and it is our view also that the FOMC should have waited to raise interest rates this time, and going forward, at least until inflation meets its target.

It is also understood that Policy makers plan to raise rates three more times in 2018, and then twice in 2019 to stabilize the economy. President Trump nominated Fed governor Jerome Powell in November to take over when Chairman Yellen ends her four-year term on February 3 next year and it is widely expected that Powell will stick to a playbook similar to that of his predecessor.

We believe that Fed’s Data Driven approach should be predicated to act on reaching certain thresholds (such as 2% Inflation Level) to prevent overcorrection. It is our view that premature interest rate hikes can result in a “hard landing” affecting both Wall Street and Main Street. Historically, impact of Interest Rate Hike / Reduction is only felt after 2 or 3 Quarters later and one hopes that this hike will not be the precursor to a Global Market Correction. Hence, we urge the presumptive Fed Chair Powell to review his predecessor’s Playbook based on prevailing Macroeconomic Environment and probably hold off on Interest Rate Hikes, until at least Inflation reached Fed’s 2% Target.