Fed Decision Day

Today is probably the end of ZIRP, and the fed will probably raise rates.

My personal take is Yellen is raising rates for 2 reasons:

  1. Yellen gains much credibility from raising rates when it is not really needed.
  2. Yellen thinks this gives the Fed additional room to cut rates when needed next time.

Raising rates will almost certainly have little or no effect on the economy now. The economy is growing at a good pace, and the transfer from spending on energy to spending on consumer goods should kick in during Q1 2016.

It’s a perfect time to raise rates if you want to have little impact on the economy, and prove you are an inflation fighter. Future economic data is likely to be strong, and employment is likely to chug along at a 250k pace over 2016. Rates could be raised slightly today and the economy will continue to grow nicely.

However, The credibility gain from raising rates today is very large. The rate hike now is not really needed. We do not have high levels of inflation, nor is the inflation rate increasing at a solid pace. Prices may be going up at a slightly higher than 2% rate, but there is a ton of noise in this signal. And last month we had low inflation – well, it was zero.

Bond market people always need assurance the fed is going to fight inflation. How better to show you are willing to fight inflation than raising rates when the data is mixed at best? Raising rates today shows you are “serious” about fighting inflation, even if it just a whiff of inflation.

The higher rates gives the Fed more room to cut rates if the economy begins to falter at some point. I suspect the effects of 25bp cuts are small, but the psychological effects on a few market participants is very large. Cutting rates if (when) we see economic weakness at least changes the tenor of the news.

I do not think interest rates make that much of a difference to most economic activity excepting real estate. I do think this rate hike will have almost no impact on real estate, and therefore have little impact on the wider economy.

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