The Fed’s Conundrum

The Fed’s Conundrum

September 29, 2017 Government 0

We keep hearing about how the Federal Reserve Bank (Fed) will start to raise interest rates, as rates have been stuck at historic lows for so many years. Ask any CD regular and they will tell you CD stands more for “Certificate of Disappointment” than “Certificate of Deposit”. People on fixed incomes who depended on interest from their CDs will give you an earful. Promise.

So can the Fed start raising rates in earnest? Will it? Should it? What’s at risk?

First, the Fed can do anything it wants as it is an independent body, and the members of the Fed can raise or lower rates at their discretion.

But will they raise rates? That’s a tougher question. The Fed would need to really raise rates should it see inflation rising above 2%. Usually, inflation would hit the 2% target with unemployment as low as it is now. In the past, such a low unemployment percentage has also meant rising wages. The problem is wages aren’t increasing all that much.

The next question is whether the Fed should raise rates. I can’t answer that question since I don’t get to see what info the Fed sees and that is not my area of expertise. So I’ll punt on this one.

The last question is the most critical… what’s at risk if the Fed doesn’t start to really raise rates? As most investors know, we’ve been in a bull market for 8½ years beginning March 9, 2009. This is one of the longest bull market runs in recent history going back to 1900. How long will it continue? Beats me. I hope for quite a while.

So (finally) here’s the conundrum: if the market does begin to tank or the economy goes into a recession or worse, the Fed will have no tools in its toolbox to alleviate the recession or steady the market from steep losses. Why, you ask? The go-to resolution in the Fed’s bag of recession tricks is to lower interest rates. But with interest rates still at historical lows, the Fed’s most effective weapon won’t be available.

Does this all make sense? So here’s hoping that inflation ratchets up so the Fed can raise interest rates. At least the CD folks will be happy again.

For my Jewish friends and clients—as we approach Yom Kippur tonight—may it be an easy fast.

Peter