I am a little stunned by the Fed’s insistence on leaving a rate hike on the table in September. What is the purpose of this? Worse, I have yet to hear a strong argument justifying this view. So far the “logic” appears to amount to “we’ve been at 0% for too long”, “the Fed wants to raise rates so they can lower them later”, “we need to fend off financial instability” or “we just need to get that first hike out of the way”. These arguments display a total lack of risk/reward analysis.
First, the natural overnight rate is 0% because a banking system with excess reserves will bid the overnight rate down to 0% naturally. People who argue that overnight rates have been “mispriced” or “manipulated” flat out don’t understand how reserve banking works. Second, raising rates 25 bps does not provide ammo for later on. If cutting rates by 500 bps over the last few years didn’t spark a recovery then why would cutting from 25 bps? Third, the Fed is contributing to global financial instability by watching the dollar climb ever higher so that argument doesn’t hold much water.
Let’s look at things from a practical perspective here. The last few months have been a game changer. We know that global economies are teetering on the edge and that US financial conditions are tightening (as seen in break-even rates). We know that a rising dollar is hurting corporate America. We know that the commodity crash is being exacerbated by the dollar’s rise which is subsequently feeding through to the global economy. But more importantly, we know that raising rates by 25 bps will do virtually nothing for the US economy. So, what we have here is a situation where the upside is literally nothing. And the downside is the potential that the Fed will exacerbate turmoil in the global economy and potentially create a positive feedback loop where the foreign weakness actually bleeds into the US economy.
Where are the cost benefit analysts at the Fed these days? Are they asleep at the wheel? Monetary conditions have already tightened in the USA yet the Fed seems insistent on tightening them further. This chatter about a rate hike in September has become indefensible.