Will The Fed Hike?
The most anticipated, discussed and fretted about meeting of the Federal Reserve Open Market Committee (FOMC) is rapidly approaching. That meeting will answer the one singular question on every investors mind – will the Fed hike interest rates?
The chart below shows that the Fed has maintained near zero overnight lending rates for a period longer than any other in history.
The consequence of extremely accommodative monetary policy has been a blistering run-up in financial asset prices as "savers" were forced to chase yield in higher risk areas. However, there has been little translation through the real economy that has continued to limp along.
It is worth remembering that the Federal Reserve uses monetary policy tools in an attempt to foster full employment and maintain price stability. In other words, the Fed lowers interest rates to stimulate economic activity and spark some inflationary pressures. The raises interest rates when the economy begins to accelerate too quickly, and inflationary pressures are building to a point that it becomes a detraction to economic growth. The chart below shows the Fed Funds rate as compared to CPI.
In the late 90's Alan Greenspan began an interest-rate hiking campaign as inflationary pressures were building in the economy. The sharp increase in rates beginning in early 1999 ultimately led to a suppression of inflation as asset prices plunged, and the economy fell into recession.
Then, starting in 2004, then Fed Chairman Ben Bernanke also launched a rate hiking campaign as housing prices, commodity prices (oil) and asset prices were rising sharply. The inflationary pressure build in the economy became a concern, and ultimately, increases in Fed interest rates once again quelled those concerns. Unfortunately, the quelling of inflation was combined with an unprecedented global financial crisis.
In the next few days, Fed Chairman Janet Yellen will announce whether or not she will begin further restricting monetary accommodation by lifting the overnight lending rate. She will do so with both inflation and economic growth at levels lower than at any other time in history.
As stated by Richard Fisher in the Financial Times:
"'The art of economics,' the old master Charles Kindleberger said, 'is to choose the right model for the given problem, and to abandon it when the problem changes shape.' At upcoming US Federal Reserve meetings, rate setters will pore over a model that was already 10 years old when they last voted to raise rates, almost a decade ago."
While Fisher believes that the recent fall in inflation is solely due to collapsing energy and crop prices, the issue of weakening economic data on a global scale, particularly that of China, may suggest much less transient nature.
As I stated previously, I think the Fed realizes that we are likely closer to the next recession than not. While raising interest rates may accelerate the pace to the next recession, it is better than being caught with rates at zero when it does occur.
It's Now Or Never
In Tuesday's post "A Sucker's Rally?," I discussed recent market action as compared to the previous bull market peaks in 2000 and 2007. During my analysis, I looked at a long-term trend of the market going back to 2009 which I thought was worth sharing with you.
Since the "debt ceiling debt default" crisis in 2011, the markets have traded within a much defined bullish trend.
That trend was decisively broken this summer and the market has yet to regain its footing. While the market "bulls" expect the markets to recover and move back to all-time highs, there is also a possibility of failure that should not be ignored.
If the market rallies back to the bullish trend channel, and fails, it will likely lead to a continuation of the current correction.
Could the market re-establish a new bullish trend channel at a lower level? Yes. However, as discussed in Tuesday's missive, the internal deterioration in the market is more consistent with the development of more major bull market peaks rather than just a correction within a bullish trend.
In every market cycle throughout history there have been times where it was vastly more beneficial to "err to the side of caution."
This is very likely one of those times.
A Word On Jobless Claims
In a recent post on the "Economy In Pictures," I received a comment suggesting that while the bulk of the economic data appears weak, jobless claims suggest a much stronger economy.
While the improvement in jobless claims is certainly welcome, they do not necessarily suggest that for few claimant there are an equal number of jobs being filled.
I discussed the phenomenon of "labor hoarding" previously stating:
"The problem that businesses are beginning to face is while they have slashed labor costs to the bone there is a point where businesses simply cannot cut further. At this point businesses have to begin to "hoard" what labor they have, maximize that labor force's productivity (increase output with minimal increases in labor costs) and hire additional labor, primarily temporary, only when demand forces expansion.
This issue of "labor hoarding" also explains the sharp drop in initial weekly jobless claims. In order to file for unemployment benefits, an individual must have been first terminated, by layoff or discharge, from their previous employer. An individual who "quits" a job cannot, in theory, file for unemployment insurance. However, as companies begin to layoff or discharge fewer workers the number of individuals filing for initial claims decline. This is shown in the chart below which shows the 4-month average of layoff and discharges versus the 4-week average of initial jobless claims."
"The mistake is assuming that just because initial claims are declining, the economy and specifically full-time employment is markedly improving. The next chart shows initial jobless claims versus the full-time employment to population ratio."
The "good news" is that for those that are currently employed - job safety is high. Businesses are indeed hiring; but prefer to hire from the "currently employed" labor pool rather than the unemployed masses. The "bad news" is that for those unemployed full-time employment remains elusive and wages remain suppressed due to the high competition for available work.
Just something to think about.