Here Comes The Hike? Maybe.

 

It wasn’t that long ago that the odds of the Fed raising rates this month were very low. In fact, the federal funds futures market put the odds at four percent for a rate increase happening. 

 

But, last week, minutes from the Fed meeting back in April came to light. These minutes showed that as long as the economy continued to make progress the Federal Reserve was ok with rate hike in June. With this happening, the futures market is putting the odds of a 0.625 percent interest rate on federal funds at roughly 30 percent.

 

Others seem to think the odds will increase in the next few weeks and a rate hike in June is more likely at about 60 percent. This is much higher than most investors now expect. 

 

However, this shouldn’t concern true equity investors. Monetary policy will continue to be loose and more than likely remain that way for the foreseeable future. Consumer prices are up 1.1 percent over the last year, while “core” consumer prices are up 2.1 percent. Either way you slice it, the federal funds rate will remain under the current inflation rate, meaning the “real” (inflation-adjusted) federal funds rate stays negative. 

 

Currently, the banking system still has $2.3 trillion in excess reserves (this is reserves in excess of what banks are legally required to hold to meet reserve requirements). The hiking of rates is not going to change this fact. However, it does mean the Fed pays banks more to hold these reserves. This is a true plus for financial firms and, in reality, money growth. In fact, M2 has grown 9.4 percent at an annual rate in the past three months, while commercial and industrial loans have grown 16.1 percent. 

 

Upping rates should help the Reserve get into a position where it can eventually start pulling down those excess reserves. Until it does though, the chance of sharply accelerating money growth does still exists. Of course, this will bring on inflation. On average, higher short-term rates tend to flatten the yield curve, with long-term rates moving up, too. But not as much as short-term rates. 

 

This time really is totally different though. Raising rates makes money growth accelerate because of all the excess reserves out there. 

 

One of the top reasons some analysts and investors still think the Fed won’t raise rates in June is that it’s not been clearly telegraphed. But, the absence of a clear signal is because they are rethinking their position on transparency. 

 

This is a recurring cycle with the Fed, as it has indicated a shift in policy was imminent only to reverse course when short-term gyrations in financial markets were shaking everyone. 

 

At the end of the day, the Fed eventually tapered, ended quantitative easing and then raised rates also. All of this happened without negative economic consequences. It looks like the Fed now thinks that if the economy deserves slightly higher rates, the best thing to do be coy. Why? Because markets would probably have a fit in response. 

 

In looking back tapering, ending QE and raising rates last December did not hurt growth. This begs the question of “why not raise rates again without generating any hysteria before the action takes place?” 

 

We’ve got a little time to go before a decision is made, so there is a chance that data goes south, further influencing the Fed’s decision. Leading up, it is important to keep an eye out on durable goods, consumer spending, inflation, and job market reports to give the Fed the confidence it needs to get straightened out and square up toward a normal monetary policy.

 

 

* – All data and numbers courtesy Brian Westbury, http://bit.ly/25J3fQQ

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Financial Planning  //  Futures  //  Stock Market