And so, the end is near, we’ve yet to face the final curtain

Tonight, Janet Yellen gets to do it her way. 9 years since the last time the Federal Reserve hiked interest rates, three and a half rounds of QE and a financial crisis later, she gets to pull the trigger. Or at least signal the gun is cocked.

Now, it’s tough to get a handle on exactly what is expected, but broadly speaking, most expect the Fed to take a pass at this meeting. Why go now? Inflation remains benign and disinflationary pressures are increasing, not decreasing; China might be a sign the world is plunging back into doom; and why risk it? Just think of the consequences, screams a world that has suckled on an endless supply of monetary milk.

Let’s get real for a second shall we?

1) any increase in interest rates from here will still be an incredibly stimulative rate

2) they have to hike at some point, or run the risk of running out of bullets into the next crisis; or run the risk of having to hike more aggressively later

3) it would reduce uncertainty over that difficult first move (as anyone paralysed by Tinder could attest)

4) and monetary policy operates with lags, as the new Head of Monetary Affairs (appointed by Yellen herself this year) has shown

Sure, maybe they could wait a bit for some more data. But why? We already know about the global disinflationary impulse, as well as the improving labour market picture specific to the U.S.  We also know Q3 data has been “just OK”. When it comes to the Fed’s dual mandate, they’re doing better than expected on employment, and slightly worse on inflation. What more would we find out in the next couple of months that might skew that picture dramatically?

No, the more important aspect to the Fed’s mandate is the extra one they received post financial crisis. They are now mandated to ensure financial stability. Zero rates for as long as the eye can see doesn’t exactly chime with that remit. Hence Yellen’s comments this year about the worrying lack of a risk premium in certain financial assets.

To that end, recent market volatility has done them a favour. Stock markets wobbled but didn’t wither and die. Emerging markets swooned but contagion remained limited. In fact various EM officials were lining up at the G20 to encourage Fed action, to reduce uncertainty that is hanging over EM countries’ borrowings in US Dollars. By acting now, they can’t be accused of derailing everything in one fell swoop.

Blondemoney is in the U.S. right now and house prices, new vehicles, and adverts for cheap mortgages suggest at least anecdotally that this economy can take it.

In fact, restoring some kind of cost of capital might help businesses to invest. Higher interest rates doesn’t always mean doom. In the nine years since the last hike would we say the economy has been weaker or stronger than the years before? Cheap money is not a symptom of a healthy economy.

Tonight they’ll either move rates, or allow effective fed funds to normalise at the top of its 0.0-0.25% corridor. Or maybe signal that is possible at October by pre-emptively pencilling in a press conference to keep that meeting “live”. Or maybe even have more than half of the ‘end of 2015 dots’ above 0.25 to suggest the majority of the Fed wants to go by year-end. Any of those actions is “hawkish” enough to surprise the market, but not ultimately scare the horses. Remember the September taper that never happened after the May taper tantrum? They went ahead and tapered in Dec anyway.

The mood of the Fed seems to be that it’s better to have a hawkish hit now to avoid a dovish pause that could cause problems later.

The Fed are moving at some point soon. Janet will be doing it her way. She’ll be stating her case, of which she’s certain. The market just has to get used to this not being the final curtain.

 

 

 

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