It appears we are about to see the Federal Reserve raise the funds rate for the first time in more than eight years. The rate has been at/near zero for an astoundingly long period of time. Yet, there is fear out there, most of it unfounded. What if the Fed is so hawkish that they raise rates quickly as they have done in the past? Of course, that is absurd if inflation stays low and the Fed has said as much, but should we believe them? If policy is set by the smartest bankers we have, then the answer is yes.
But, the market may not be ready for rate hikes you say? Well, that is always the case, isn’t it? The Fed will start cutting rates when it seems the wheels are starting to fall off the economy’s cart. Since 2008 the Fed has provided enough stimulus to give the economy enough of a boost following the near disaster of the financial crisis. The economy has been on near zero interest rates for the nearly the entire time, and it seems time to remove some of the generous accommodation. On several occasions, mostly this year the Fed has been ‘trying’ to start the process of normalizing the interest rate structure.
But unfortunately, the timing has never been just right. Is there ever a good time for cooling down the economy? That may be the effect of a rate hike following the long time accomodative stance. How will the market react to a rate hike? Perhaps the same as the ‘taper tantrum’, which was a fit the market exhibited like a 3 year old throwing a temper tantrum when Quantitative Easing (QE) removal was being considered. The removal of QE was carefully orchestrated and slowly removed so as to not cause ‘upset stomachs’, a process that lasted for about one year.
This time around with interest rates, the expectation was for that hike to occur on several occasions, but something would get in the way. For example, this past September a rate hike was all but assumed until some turmoil in Greece and China caused the Fed to step back. In June it appeared likely for the first rate hike, yet the jobs reports were weak and they waited. December is the last meeting of 2015 and it seems a slam dunk for a rate hike – yet the Fed has NEVER raised rates in December.
Many are betting this will be it, and the timing for any future rate hikes will be very slow. Fed funds futures are showing the likelihood of the next rate hike is priced in for next September. Of course, too much data and time to be that accurate but one thing is for sure – the market will grumble about it but will eventually have to deal with normal conditions. Which isn’t all that bad.