The question on the mind of market participants is whether or not the Fed will decide to pull the trigger on interest rates at some point this year.
After originally predicting four rate hikes in 2016 (and then revising that outlook to two rate hikes), the Federal Reserve has yet to change interest rates even once through the first seven months of the year.
One must remain skeptical that the Fed will pursue any policy changes so close to the presidential election this November. This is part of the central bank’s strategy for never appearing to be politically motivated—but it may actually belie its underlying bias.
Goosing the Economy
As is typically done during election years, the policies and public statements of the Fed seems to be an attempt to overheat the economy. The most glaring evidence of this the prolonged period that the central bank has kept its benchmark federal funds rate unconventionally low (despite stating its intentions are to eventually normalize interest rates).
This reliance upon low interest rates to keep economic activity churning, especially in the financial sector, does not square with the hawkish rhetoric we have seen from Fed officials throughout most of 2016. Then again, their hawkish outlook bears no resemblance to the real world, either.
The byproducts of this goosing of the economy are clear, though. U.S. stocks have yet again hit record-highs despite abysmal earnings from most American companies and weak GDP growth that is only around 1%. Even financial stocks (i.e. banks) that have been getting hammered are now positive for the year!
Politics as Usual?
By doing nothing, the Fed hopes to avoid seeming like it wants to tip the election for either major party. Reversing direction and actively cutting rates would undoubtedly be seen as politically motivated. However, its inaction benefits the Democrats nonetheless.
Although standing pat may insulate the central bank from appearing to consciously favor the incumbent party, it’s likely that Chair Yellen and the Fed are indeed biased toward the left. (Like the Supreme Court, the Fed has become increasingly liberal over the years.) While many Republicans continue to push for a rate hike, the longer that easy-money policies remain in place, the “better” the economy may look around election time.
Of course, relying upon near-zero interest rate policies (NIRP) for longer creates the distinct possibility that the Fed will overshoot on inflation and hurt the economy down the road. This is why the Fed’s policies are most glaring during an election year: you can’t perfectly predict the effect of monetary policy down the road, so it’s more difficult to say that a given outcome was engineered as a political favor.
Yet, with the 2016 narrative supposed to be all about rate hikes, the lack of action from the FOMC smacks of a short-term political decision to keep stock markets—and Democrats—happy.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.