Published December 10, 2018
“To Raise or not to Raise (Rates) is the question…” – would best describe Federal Reserve’s position, if we were to apply the Bard of Avon’s immortal quote from Hamlet, to the likelihood of hiking the Interest Rate in their December 19 FOMC Meeting. Trade war fears along with the specter of a possible economic slowdown have sent markets down significantly in the last couple of weeks. Consequently, it is reported by CME that Investors currently see a 73.2% chance of a rate hike following the December Fed meeting, while a week ago, the probability for a rate hike on December 19 was at 84.4%.
The Fed currently holds its benchmark funds rate, which banks charge each other for short-term lending, at a target between 2 percent and 2.25 percent. Due to market volatility in the last couple of weeks the market has also reduced the chances of future increases, assuming Federal Open Market Committee approves another quarter-point move higher on Dec. 19, there only will be one more in 2019 before it stops.
We strongly agree with President Trump’s assertion that the Fed’s course of action toward higher rates poses a significant threat to the economy. The Commerce Department reported on Thursday that a key measure of inflation rose by 1.78 percent over the 12 months ending in October, below the 2 percent annual pace that the central bank regards as optimal.
The Fed is now facing a conundrum that can affect both High Street and Wall Street – if they move ahead with a hike in December FOMC meeting, the Markets could react negatively as they have been doing for a while now. However, if the Fed decides not to hike in December, then there is a possibility that the Markets may assume that the situation is grave(r) than expected, since the Fed has halted it’s rate hike, and could go into a tailspin! This situation could also be summed up in another way “da***ed if you do and da***ed if you don’t“.
However, we believe, as we have indicated before, that the Fed’s decision should be data driven and not based on sentiment or other extraneous circumstances. We do not see a sign that the economy is in danger of overheating. Hence, it is our view that since inflation has not breached the 2% target coupled with slowing growth and increased market volatility, it may be a good time to take a pause and not hike rates in December 2018 and the next meeting following it. This period can be used to observe market conditions and consolidate gains. Such a course of action, will also in our opinion, increase the Fed’s credibility by showing a willingness to change its view as economic and market conditions evolve.