All Systems Go For A Rate Hike

All systems are go for an interest rate hike on Wednesday.

If, as is widely assumed, the Federal Reserve approves the first interest rate hike in nearly a decade at their December meeting this week, all the focus will move instantly away from the timing of the initial hike and toward the trajectory of future rate hikes.

That shift won’t disappoint Fed officials.

Indeed, for months Fed Chair Janet Yellen has sought to play down the timing of the first rate hike, stressing instead the path of rates after the initial increase. The Fed chief and her colleagues have unanimously emphasized that rates will move higher “gradually” over the next few years as the U.S. economy continues to heal from the worst economic crisis since the Great Depression.

The policy-setting Federal Open Markets Committee meets Tuesday and Wednesday in Washington, D.C., and it’s widely believed FOMC members will approve a small rate hike of 0.25%. The Fed will announce its decision at 2 p.m. EST on Wednesday and Yellen will hold a press conference at 2:30 p.m EST to further explain the Fed's decision.

Some analysts believe a rate hike is overdue.

“On Wednesday, the Federal Reserve will likely finally raise interest rates from zero in an economy which should long ago have been taken off bedrest,” said David Kelly, chief global strategist at J.P. Morgan Funds.

Beyond the Fed’s vow to move rates “gradually,” what happens next is pretty much anyone’s guess.

Kelly said Fed officials could offer some clues in their statement on Wednesday, however, “there is considerable uncertainty about how the Fed will characterize future moves,” he noted.

Kelly added that the “very-dovish FOMC” will likely continue to telegraph their reluctance toward raising rates too high too quickly, a blunder that could put a serious drag on the already-fragile recovery. “It would not be surprising,” Kelly added, “if Janet Yellen in her press conference emphasizes the possibility that the Fed could halt or reverse the tightening move in 2016 if economic conditions worsened.”

Earlier this year the Fed established two conditions for raising rates: “further improvement” in labor markets, and “reasonable confidence” that inflation is moving higher toward the Fed’s 2% target.

Two consecutive months of strong labor reports have certainly shown “further improvement” in the jobs market, and recent hints that wages are moving higher are fueling belief that inflation will soon be ticking higher as well.

Still, Mark Williams, a former Fed examiner who now teaches banking at Boston University, said he’s skeptical inflation will move higher as quickly as Fed officials have predicted. Consequently, he said there’s a good chance this week’s expected rate hike could be a "one and done."

“After it’s done once I think there’s a good chance rates could just sit for some time,” Williams said.

Williams also believes the Fed should have initiated liftoff earlier in the fall. “I think if you’re the Fed you kind of want to test the system out, and September would have been a better time to do that,” he said. “September would have given ample time for the pipes to be tested before year end and the uncertainty that comes at the end of the year.”

The Fed has said for months that any decision to raise rates will be “data dependent.” Most of the recent data has built momentum toward a Dec. 16 rate hike. What’s more, virtually every public statement out of the Fed – notably from such influential members as Yellen, Vice Chair Stanley Fischer and New York Fed President William Dudley – has suggested a December liftoff.

Rates have been held at a near-zero range since December 2008 when they were slashed to an unprecedented low level amid the darkest days of the financial crisis. Since then the unemployment range has fallen to 5%, below the level where it stood at the beginning of the crisis, and all of the 8.7 million jobs lost during the recession have been recovered.

Now Fed officials, anxious to “normalize” monetary policy, seem to believe the U.S. economy is strong enough to absorb the higher borrowing costs that will follow a rate hike.