The wait is over: the Federal Reserve will almost certainly raise interest rates on December 16.
This would be the first Fed rate hike in over nine years and comes after what has been a tedious year for investors, who spent a inordinate amount of energy thinking about whether or not the Fed would increase its benchmark interest rate, which has been pegged at 0%-0.25% since December 2008.
The last time the Fed actually raised rates was June 2006, but after Friday’s November jobs report met expectations and confirmed that even with tremendous gains over the last several years the US labour market continues to strengthen, the Fed has what it needs to begin the process of raising rates.
In an email following the report, Neil Dutta at Renaissance Macro said simply, “NO MORE EXCUSES.”
“Instead of wasting time focusing on abstract concepts such as equilibrium interest rates and NAIRU, perhaps the Fed should just see what is happening in front of its face,” Dutta wrote. “The message from November’s jobs is clear, the US labour market is unambiguously strengthening.”
Economists at BNP Paribas said that after Friday’s report it’s, “All systems go” for the Fed to raise rates in December.
Ian Shepherdson at Pantheon Macroeconomics said of the report, “More than enough to seal the deal for the 16th.”
So there you have it.
Earlier this week, commentary from Fed chair Janet Yellen made it clear that barring a massive surprise on Friday, December would be the month for Fed action.
In a speech at the Economic Club of Washington, D.C., Yellen said that if the Fed waits too long to raise interest rates it risks needing to tighten financial conditions quickly at a later date. And given that the Fed has been clear it expects to raise interest rates slowly once it begins this process — which in Fedspeak in “normalizing” policy — this outcome would be particularly discouraging.
Here was the key passage from Yellen:
However, we must also take into account the well-documented lags in the effects of monetary policy. Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession. Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and thus undermine financial stability.
Speaking on Capitol Hill on Thursday, Yellen said that to continue absorbing the “slack” that remains in the labour market, the economy would need to add fewer than 100,000 jobs per month. At a rate of over 200,000, the current pace of job gains is, in Yellen’s view, “quite a bit” above what’s needed to see further progress in the labour market.
And looking only at the labour market, the Fed has met its goals and conditions are clearly in place to begin a Fed rate hike cycle.
Inflation, however, remains below the Fed’s stated 2% target — the latest data showed core PCE prices, the Fed’s preferred inflation measure which excludes the volatile costs of food and gas, rose 1.3% in the third quarter — as it has for much of the last few years.
Following the Fed’s September policy decision, Yellen reiterated that the Fed needs to be confident inflation will eventually return to its target in order to raise interest rates, even going so far as to say the Fed’s credibility rests on meeting its inflation goal.
Prominent economic commentators, notably Nobel Laureate Paul Krugman, have been vocal that the Fed needs to keep interest rates near 0% until inflation gets closer to the Fed’s stated goal.
And the crux of this argument is that if the Fed gets too aggressive on raising interest rates and the economy tips back into recession after, say, a mere 0.5% interest rate hike, the Fed will be left with little wiggle room to stabilise the economy (which it typically does by cutting rates).
Said another way, the risks of raising rates too early are asymmetric and weighted to the downside: moving too early is far worse than waiting too long.
But throughout 2015 it’s been clear, particularly in signals from Fed chair Yellen, that this is the year the Fed hoped to get off of 0%, an emergency policy setting that has been in place since the depths of the financial crisis.
And in comments on Thursday, Yellen said a rate hike would also be a day to commemorate the progress made by the economy after the worst recession since the Great Depression.
“When the Committee begins to normalize the stance of policy, doing so will be a testament, also, to how far our economy has come in recovering from the effects of the financial crisis and the Great Recession,” Yellen said.
“In that sense, it is a day that I expect we all are looking forward to.”
That day will be December 16, 2015.
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