MorningWord 8/29/16: A Difficult Hike

by Dan August 29, 2016 9:58 am • FREE ACCESS

On Friday Federal Reserve Chairwoman Janet Yellen said what we already knew:

“In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months,”

That and a quarter will get you a cup of coffee.

Fed Fund Futures are now pricing a 44% probability of a hike at the Fed’s September meeting, per Bloomberg:


To put that in historical perspective, let’s recall some research from Goldman Sach’s back in May, per CNBC:


I suspect this is a multi-step process and jawboning may achieve the desired tightening without making some sort colossal error where they are seen as affecting the election in November. Donald Trump believes a lot of conspiracy theories, but there is one that he mentions from time to time that’s actually true. The financial powers that be do not want to see him in the White House come January.

For some evidence look to a poll by the WSJ of all “45 surviving former members of the White House Council of Economic Advisers under the past eight presidents, going back to Richard Nixon”:


This sentiment is consistent no matter party affiliation and represents the type of people that would be rubbing shoulders with current FOMC members at the most boring cocktail parties in all of Georgetown.

This poll gives us insight into the Fed’s thinking into November. I think the chances of a rate raise at the Sept 21st meeting is unlikely. It’s possible that no matter what this Friday’s August employment data brings (great preview from Mohamed A. El-Erian for BloombergView), that 44% chance that Fed Funds futures are priing in Sept starts going the other direction towards zero afterwards. Remember all of the opportunities the FOMC has had to hike over the past year where they were scared by their own shadow on things way more insignificant than a presidential election. This isn’t a group that tends to make sudden moves.

And if you think the Fed is hesitant to raise in late September for those same reasons, then the probability of a hike at the November 2nd meeting is close to zero less than a week before the election.  So it’s likely that December it is. And like last December, when the Fed finally raised off of the zero interest bound (and the first raise since June 2006) the Fed Fund futures will be implying a series of 3 hikes in 2017 to get Fed Funds back above 1%.

While the pace of hikes, or who will be in the White House in 2017 remains somewhat uncertain, whether the President will be faced with a recession in their first term isn’t. It’s almost guaranteed. In a February 2015 post (here) on A Wealth of Common Sense, Ben Carlson, detailed our nation’s history of recessions, and writes that since WWII:

recessions have still occurred once every five years or so since then. The longest period of calm in the economic cycle was during the 1990s when the economy went a full decade without a down cycle.


Most Fed officials want to normalize rates sooner than later, so they at the every least have some traditional tools (rate cuts) to combat the next recession, as the word is starting to get out that they fear the potential for negative rates. But they also know they’re in a bit of a trap, because as Lawrence Summers believes getting rates back to a point to where they can once again be lowered effectively during a recession is probably the very thing that causes our next recession.