Fed Raises Rates For No Good Reason At All

The Fed raised interest rates yesterday by 1/4 of a point despite recent economic performance actually pointing to a slowdown rather than an overheated economy. Importantly, the current inflation measures all point to a rate blow the Fed’s target of 2%. But, ever the optimists, the Fed is predicting we will soon be rapidly eclipsing that target by .1% as early as 2019. And this is coming from a group that has underestimated inflation for the last 8 years. What, exactly, are they thinking?

Let’s take a look at the numbers to see why this rate hike is so poorly timed. I have already written about the collapse in retail, both in sales and in hiring, with over 100,000 jobs lost in that industry just this year. May’s unemployment report was also particularly underwhelming, with the decline in the overall rate driven by a massive exodus of people from the labor market far more so than a surge in hiring.

Even the Fed’s forecasts for GDP growth never exceeds 2.2% over the next two years, and those expectations have dropped since the last meeting in March.

Kevin Drum over at Mother Jones has kindly provided even more important data points. The trend of average hourly wage growth has actually been decreasing since the end of 2015.

The Fed’s favorite inflation measure has hardly budged, has actually decrease since the beginning of the year, is currently below the level it reached in mid-2014, and has yet to threaten the 2% benchmark.

In fact, the markets suggest that inflation won’t reach the 2% level anytime in the near future as TIPS and swap rates in the 5-10 year range expect an inflation rate between  around 1.5% and 1.75%. As Larry Summers points out, the Fed’s current matrix shows four rate hikes over the next year and a half while the market seemingly expects only two.

This has been the problem for the Fed for the last few years and, in some ways, they continue to get boxed in by their own faulty forecasts. They continually signal to the markets that they will raise rates but the data just doesn’t support it. Often, they have been embarrassingly forced to back off as happened in May of last year. But, at times, like yesterday, they seem to drive ahead solely to convince the markets that they remain credible in their commitments. To say that approach may not be an effective way to manage the economy would be a gross understatement.

We are now in the eighth year of recovery and it seems far more probable that the economy is more likely to slow down rather than become overheated after such a prolonged period of expansion. The Republicans in Congress are screwing around with one-fifth of the American economy in total secrecy. Families are becoming increasingly concerned that health care will no longer be available, much less affordable. We have probably the most extreme Congress in decades and a President who clearly has no grasp of policy details as we approach another battle over the debt ceiling, with default as a looming possible outcome. Republicans are also intending to massively change the tax code and explode the national debt even further.

Everything in the above suggests greater instability and possible economic contraction. Nothing suggests the need to raise interest rates. And just to show how much the markets are ignoring the Fed’s actions and intentions, mortgage rates, which are usually highly correlated with interest rates, actually dropped to an eight month low yesterday, focusing more on the weak Consumer Price Index number rather than on the Fed’s announcement of a rate hike.

All this makes it hard to understand why the Fed took action yesterday. In fact, the only reason that truly makes any sense is that the Fed is desperate to push up rates whenever it can simply to have ammunition to cut rates when the expected downturn in the economy does come. Of course, that is quite probably a self-fulfilling policy.