- By: Sanjay Pawar
As we all know, the markets are obsessed with, whether or not the Federal Reserve will raise rates. The markets seem to move based on expectations of Fed rate move. At least there is empirical evidence that would suggest so. Earlier this year the general consensus was that the Fed will raise rates twice in 2016. I have maintained all along that the Fed may not and should not raise rates in 2016.
That said, I don’t know what the Fed is going to do with rates at its next meeting. I like to look at interest rates from a very basic economics and business fundamental perspective. I am not suggesting that the market or the Fed does not.
Here are some reasons why, I question the need to raise interest rates:
- Inflation (CPI all items) was at 1.06% in August 2016. True, the PCE Index (ex Food and Energy) was up 4.30% at last reading. But it appears that low food and energy prices have kept overall inflation low. In my opinion, and there could be any number of arguments against this, Food and energy (basic necessities of life) should be of utmost concern for policy makers because they affect standard of living at the very basic level. I mean, think about it, if food and energy was going up by 10% a year I don’t think it would matter much if prices of everything else were dropping. So is there really an inflation concern?
- Real GDP growth was around 1.2% in Q2 of 2016. So it is not like the economy is growing at an aggressive rate in this low rate environment. Looking at the last 20 years, we are near the average growth rate during the last 20 years.
- Global Interest rates: Globally Central Banks are mirroring the stimulus policy of the US Federal Reserve, with their bond buying programs and lowering bench mark interest rates. Europe has done so, China and India. Japan has been at negative interest rates for a long time and is still struggling with deflation! So why do we want to go against the trend and stall our economy with higher interest rates.
- Commodities are trading at multi year lows. That is another reason not to worry about cost push inflation. And arguably commodities are trading at multi year lows because global demand has tapered off. Another sign of weak economic optimism.
In this global low interest rate environment what would happen if the US started raising interest rate? For one, our currency would strengthen against other major currencies, which could make our exports less competitive. Consequently, this may stall our economy, which does not seem to be on a very strong footing to begin with.
Business credit uptake may drop because businesses would not be willing to take risks with borrowing money at higher costs, when global economic conditions are not exactly strong.
There are other economic consequences of higher interest rates which I do not see why the Federal Reserve would want to take them on at this point.
In conclusion, again, I don’t know what the Federal Reserve Chair is going to do. But if I was responsible for making the call, I would not rush to raise rates.