Time for a Fed reality check
Untitled DocumentTime for a Fed reality check
The Federal Open Market Committee meets Tuesday and Wednesday and, for the first time since last September, they won’t cut interest rates. Lately, the talk has been all about when the Fed will raise interest rates, with expectations calling for a rate hike as soon as August. But a rate hike is doubtful and that lack of a rate hike at the upcoming Fed meeting will serve as a reality check.
The prospects for Fed interest rate hikes are rooted in inflation data. The age-old recipe for combating inflation is to have the Fed raise interest rates. But this isn’t your grandfather’s inflation because it isn’t due to an overheating economy or too many dollars chasing too few goods. This brand of inflation is instead, one that is largely the Fed’s own doing and one they have little power or latitude to undo in the near future.
This inflation is one that is being imported via higher costs for commodities, most notably oil. Here is where the Fed’s repeated and aggressive interest rate cuts have played a significant role by helping erode the value of the U.S. dollar. Oil, after all, is priced in U.S. dollars. But inflation isn’t just a U.S. phenomenon right now, it is a global phenomenon. And as a result, the Federal Reserve isn’t the only central bank looking at eventually boosting interest rates in response. The problem is this: The U.S. economy, the housing market, and yes even the looming presidential election all stand as barriers to the Fed taking action. Our counterparts overseas, most notably the European Central Bank, are more focused on inflation and don’t have economic and housing environments comparable to what we’re experiencing in the U.S. So the Europeans may well get a head start on Ben Bernanke in actually raising interest rates, likely bringing about another round of dollar depreciation.
So what can the Fed do? Talk. And that is exactly what the members of the FOMC have been doing plenty of, jawboning aimed at both the dollar and inflation. The rhetoric has been kicked into overdrive in recent weeks and has helped drive home the point that the Fed is not inclined to cut interest rates further.
The transition that has taken place since the last FOMC meeting concluded on April 30 is that we are no longer in a falling rate environment. With the Fed moving to the sidelines and inflation data taking over the spotlight, Treasury yields have rebounded mightily from the lows seen in March and April. Mortgage rates staged a sharp run-up while yields on certificates of deposit have been clawing their way back to respectability. But the Fed is not in a position to hike interest rates any time soon — think December at the earliest — and that will be a reality check when their meeting concludes June 25.