The emerging market turmoil that developed this year was a total game changer for Fed policy. Even though the US economy looked relatively strong (I’d argue it has been muddling through all along) the argument in favor of rate hikes shifted once the foreign economy started to falter. Especially when we started hearing about how much turmoil the rising dollar was causing in commodity markets and economies that had borrowed in dollar denominated instruments. The risk of raising rates in such an environment is that the dollar exchange rate becomes a one way bet that puts further pressure on foreign currencies, debts and commodities. This creates a positive feedback loop in which the global economy weakens to a point where it starts having a material impact on domestic output (at a time when the domestic economy is still muddling through).
Anyhow, this morning’s payrolls report likely put the kibosh on rate hikes this year. Private payrolls rose just 118,000 and wages were non-existent. The US economy is indeed muddling through still. In fact, it’s perhaps even a little weaker than I’ve expected and that’s not saying much. But here’s an interesting thought about the current state of affairs – this discussion could quickly shift from raising rates to cutting rates with more QE.
In the last few days there has been chatter about comments made by Stan Fisher and Ben Bernanke about going negative. They both appear to embrace the idea more and more. Yes, that’s how weak the current environment is. The economy remains so fragile following the financial crisis that it can’t even sustain a 0.25% rate hike. In fact, as I’ve long argued, we’ve been due for more stimulus for a long time. And the bad news is that we might just get it in the form of all the things I’ve been arguing against (more monetary policy). So, don’t be shocked if the discussion quickly shifts here from raising to going negative. And that would likely be a positive in the aggregate because it would halt a lot of the dollar driven problems in foreign markets and could actually stabilize the US economy a bit as fears abroad lessen and we continue to muddle along.