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3 Reasons the Fed Would be Wise to Wait on Rate Increases

In recent speeches the Federal Reserve has prepared financial markets for rate increases.  It no longer sounds like a matter of if, but when. And that when could make a big difference to the US economy.

In a speech today at the Atlanta Fed, Jan Hatzius voiced his opinion that the Fed should wait until “very late 2015, early 2016”. Although I can understand the justification for rate increases at SOME point, I’ve generally agreed with Hatzius and feel increasingly confident about that. I think we can justify this based on several rational premises:

1) The US economy is not overheating and actually appears to be softening.  Recent data has been anything but strong. ISM data, regional manufacturing report, CAPEX data, consumer spending, retail sales and even Q1 GDP all appear to be coming in below expectations. This isn’t necessarily a panic sign, but it’s not consistent with an economy that is overheating and in need of monetary tightening.

2) Wage growth remains weak. Although there are some signs that wage growth could surprise on the upside, I think that there are reasonable signs that wage growth remains weak. More importantly, we are coming off of very low historical levels which gives the Fed some room to be slow to act.

3) Financial instability is only showing marginal signs of fragility. Yes, there are some worrisome signs in some markets. Some valuation metrics are high, there are arguable bubbles in some sectors of the markets and borrowing in financial markets is high.  But these are more micro issues than macro issues. The Fed is eager to get ahead of any potential financial instability, but I actually worry that sharp rate increases in a weak economic environment could contribute to financial instability more than deter it.